­­FIN310 Class Web Page, Fall ' 20

Instructor: Maggie Foley

Jacksonville University

 

The Syllabus    

Term project (due with final)

 

Weekly SCHEDULE, LINKS, FILES and Questions

Chapter

Coverage, HW, Supplements

-        Required

References

 

Chapter 1, 2

Live Stream web link

 

 Tuesday  -  Group 1 in classroom                                        Thursday   -    Group 2 in classroom

8/18 – syllabus, market watch game                          

8/20 – chapter 1, flash crash, high frequency trading

8/25 – High frequency trade

8/27 – flash crash, chapter 2: what is money

9/1 – M1, M2, fractional banking system I

9/3  fractional banking system II, bitcoin (Thanks, Chris)

9/8 – order types

9/10 – IPO, SEO

9/15 – Time value of money

9/17 – First Mid Term exam, online, 11am-3pm, answers posted on bb

9/22 – bond concept, risk, finra.com for bond info

9/24 – high yield bond discussion

9/29 – credit rating, z score

10/1 – z score, market news regarding bond downgrading

10/6 – yield curve, inverted yield curve, flattened yield curve

10/8 – Diversification, S&P500 index: weights, losing and winning stocks

10/13 – Mutual fund, Risk tolerance test, investment strategy

10/15 – QQQ vs SP500

10/20 – stock market, behavior finance part i

10/22 – behavior finance part ii

10/27 – Derivatives

10/29 – Second Mid Term

11/3 – Commercial banks I

11/5  Commercial banks II

11/10 – Investment banks

11/12 – Fed I

11/17 – Fed II, Monetary Policy I

11/19 - Monetary Policy II

Final On 11/21, Saturday, noncumulative, T/F, on blackboard under course introduction; all homework due; term project due;

 

 

 

 

Marketwatch Stock Trading Game (Pass code: havefun)

Use the information and directions below to join the game.

1.     URL for your game: 
https://www.marketwatch.com/game/jufin310-20fall

2.   Password for this private game: havefun

3.     Click on the 'Join Now' button to get started.

4.     If you are an existing MarketWatch member, login. If you are a new user, follow the link for a Free account - it's easy!

5.     Follow the instructions and start trading!

 

Discussion:  How to pick stocks (finviz.com)

Daily earning announcement: http://www.zacks.com/earnings/earnings-calendar

IPO schedule:  http://www.marketwatch.com/tools/ipo-calendar

 

 

Chapter 1 Introduction 

Introduction to Capital Markets - ION Open Courseware (Video)

 

image002.jpg

 

Note:

Flow of funds describes the financial assets flowing from various sectors through financial intermediaries for the purpose of buying physical or financial assets.

*** Household, non-financial business, and our government

 

Financial institutions facilitate exchanges of funds and financial products.

*** Building blocks of a financial system. Passing and transforming funds and risks during transactions.

*** Buy and sell, receive and deliver, and create and underwrite financial products.

*** The transferring of funds and risk is thus created. Capital utilization for individual and for the whole economy is thus enhanced.

 

For class discussion:

1.     What is the business model of each player in the above graph?

2.     Which player is the most important one in the financial market?

3.     Can anyone of them be removed from the market?

 

 

Chapter 1 

 

 

ppt

 

1.       What are the six parts of the financial markets

Money:

·         To pay for purchases and store wealth (fiat money, fiat currency)

 

What is Bitcoin for BEGINNERS in 7-Min. & Bitcoin Explained | What is Cryptocurrency Explained 2019

 

Financial Instruments:

·         To transfer resources from savers to investors and to transfer risk to those best equipped to bear it.  

 

Where do student loans go? (video)

An Introduction to Securitized Products: Asset-Backed Securities (ABS) (video)

 

 

Financial Markets:

·         Buy and sell financial instruments

·         Channel funds from savers to investors, thereby promoting economic efficiency

·         Affect personal wealth and behavior of business firms. Example?

 

Financial Institutions.

·         Provide access to financial markets, collect information & provide services

·         Financial Intermediary: Helps get funds from savers to investors

 

Central Banks

·         Monitor financial Institutions and stabilize the economy

 

Regulatory Agencies

·         To provide oversight for financial system.

The role of financial regulation (Video) -  Do you agree with her?

 

2.      What are the five core principals of finance

  • Time has value
  • Risk requires compensation
  • Information is the basis for decisions
  • Markets determine prices  and allocation resources
  • Stability improves welfare

 

 

3.      What is stock?

 

4.      Why do we need stock exchanges?

·         Transparency

·         Anonymous

·         Guarantee and settlement

·         Regulated

 

5.      What is high frequency trading? pros and cons

 

Ppt

 

Videos

High Frequency Trading (video)

 How high frequency trading works (video)

 

Strategies And Secrets Of High Frequency Trading (HFT) Firms

 

By PRABLEEN BAJPAI

Updated Sep 21, 2014

 

Secrecy, Strategy and Speed are the terms that best define high frequency trading (HFT) firms and indeed, the financial industry at large as it exists today.

 

 

HFT firms are secretive about their ways of operating and keys to success. The important people associated with HFT have shunned limelight and preferred to be lesser known, though that's changing now.

 

 

The firms in the HFT business operate through multiple strategies to trade and make money. The strategies include different forms of arbitrage – index arbitrage, volatility arbitrage, statistical arbitrage and merger arbitrage along with global macro, long/short equity, passive market making, and so on.

 

 

HFT rely on the ultra fast speed of computer software, data access (NASDAQ TotalView-ITCH, NYSE OpenBook, etc) to important resources and connectivity with minimal latency (delay).

 

Let’s explore some more about the types of HFT firms, their strategies to make money, major players and more.

 

HFT firms generally use private money, private technology and a number of private strategies to generate profits. The high frequency trading firms can be divided broadly into three types.

 

The most common and biggest form of HFT firm is the independent proprietary firm. Proprietary trading (or "prop trading") is executed with the firm’s own money and not that of clients. LIkewise, the profits are for the firm and not for external clients.

Some HTF firms are a subsidiary part of a broker-dealer firm. Many of the regular broker-dealer firms have a sub section known as proprietary trading desks, where HFT is done. This section is separated from the business the firm does for its regular, external customers.

Lastly, the HFT firms also operate as hedge funds. Their main focus is to profit from the inefficiencies in pricing across securities and other asset categories using arbitrage.

 

Prior to the Volcker Rule, many investment banks had segments dedicated to HFT. Post-Volcker, no commercial banks can have proprietary trading desks or any such hedge fund investments. Though all major banks have shut down their HFT shops, a few of these banks are still facing allegations about possible HFT-related malfeasance conducted in the past.

 

 

How Do They Make Money?

 

There are many strategies employed by the propriety traders to make money for their firms; some are quite commonplace, some are more controversial.

 

These firms trade from both sides i.e. they place orders to buy as well as sell using limit orders that are above the current market place (in the case of selling) and slightly below the current market price (in the case of buying). The difference between the two is the profit they pocket. Thus these firms indulge in “market making” only to make profits from the difference between the bid-ask spread. These transactions are carried out by high speed computers using algorithms.

 

Another source of income for HFT firms is that they get paid for providing liquidity by the Electronic Communications Networks (ECNs) and some exchanges. HFT firms play the role of market makers by creating bid-ask spreads, churning mostly low priced, high volume stocks (typical favorites for HFT) many times in a single day. These firms hedge the risk by squaring off the trade and creating a new one.

 

Another way these firms make money is by looking for price discrepancies between securities on different exchanges or asset classes. This strategy is called statistical arbitrage, wherein a proprietary trader is on the lookout for temporary inconsistencies in prices across different exchanges. With the help of ultra fast transactions, they capitalize on these minor fluctuations which many don’t even get to notice.

 

HFT firms also make money by indulging in momentum ignition. The firm might aim to cause a spike in the price of a stock by using a series of trades with the motive of attracting other algorithm traders to also trade that stock. The instigator of the whole process knows that after the somewhat “artificially created” rapid price movement, the price reverts to normal and thus the trader profits by taking a position early on and eventually trading out before it fizzles out. 

 

The Players

 

The HFT world has players ranging from small firms to medium sized companies and big players. A few names from the industry (in no particular order) are Automated Trading Desk (ATD), Chopper Trading, DRW Holdings LLC, Tradebot Systems Inc., KCG Holdings Inc. (merger of GETCO and Knight Capital), Susquehanna International Group LLP (SIG), Virtu Financial, Allston Trading LLC, Geneva Trading, Hudson River Trading (HRT), Jump Trading, Five Rings Capital LLC, Jane Street, etc.

 

Risks

 

The firms engaged in HFT often face risks related to software anomaly, dynamic market conditions, as well as regulations and compliance. One of the glaring instances was a fiasco that took place on August 1, 2012 which brought Knight Capital Group close to bankruptcy--It lost $400 million in less than an hour after markets opened that day. The “trading glitch,” caused by an algorithm malfunction, led to erratic trade and bad orders across 150 different stocks. The company was eventually bailed out. These companies have to work on their risk management since they are expected to ensure a lot of regulatory compliance as well as tackle operational and technological challenges.

 

The Bottom Line

 

The firms operating in the HFT industry have earned a bad name for themselves because of their secretive ways of doing things. However, these firms are slowly shedding this image and coming out in the open. The high frequency trading has spread in all prominent markets and is a big part of it. According to sources, these firms make up just about 2% of the trading firms in the U.S. but account for around 70% of the trading volume. The HFT firms have many challenges ahead, as time and again their strategies have been questioned and there are many proposals which could impact their business going forward.

 

 

 

6.      What is flash crash? (refer to the two articles on the right)

Flash crash

From Wikipedia, the free encyclopedia

flash crash is a very rapid, deep, and volatile fall in security prices occurring within an extremely short time period. A flash crash frequently stems from trades executed by black-box trading, combined with high-frequency trading, whose speed and interconnectedness can result in the loss and recovery of billions of dollars in a matter of minutes and seconds.

Occurrences

The Flash Crash

This type of event occurred on May 6, 2010. A $4.1 billion trade on the New York Stock Exchange (NYSE) resulted in a loss to the Dow Jones Industrial Average of over 1,000 points and then a rise to approximately previous value, all over about fifteen minutes. The mechanism causing the event has been heavily researched and is in dispute. On April 21, 2015, the U.S. Department of Justice laid "22 criminal counts, including fraud and market manipulation" against Navinder Singh Sarao, a trader. Among the charges included was the use of spoofing algorithms.

2017 Ethereum Flash Crash

On June 22, 2017, the price of Ethereum, the second-largest digital cryptocurrency, dropped from more than $300 to as low as $0.10 in minutes at GDAX exchange. Suspected for market manipulation or an account takeover at first, later investigation by GDAX claimed no indication of wrongdoing. The crash was triggered by a multimillion-dollar selling order which brought the price down, from $317.81 to $224.48, and caused the following flood of 800 stop-loss and margin funding liquidation orders, crashing the market.

British pound flash crash

On October 7, 2016, there was a flash crash in the value of sterling, which dropped more than 6% in two minutes against the US dollar. It was the pound's lowest level against the dollar since May 1985. The pound recovered much of its value in the next few minutes, but ended down on the day's trading, most likely due to market concerns about the impact of a "hard Brexit"—a more complete break with the European Union following Britain's 'Leave' referendum vote in June. It was initially speculated that the flash crash may have been due to a fat-finger trader error or an algorithm reacting to negative news articles about the British Government's European policy.

FLASH CRASH! Dow Jones drops 560 points in 4 Minutes! May 6th 2010 (video)

Flash Crash 2010: Trader Relives Nightmare Three Years Later (video)

Flash Crash: Can Only One Trader Be Responsible? (video)

What Is High-Frequency Trading? Finance, Algorithms, Software, Strategies, Firms (2014) (Video, optional)

THE HUMMINGBIRD PROJECT Clips + Trailer (2019) (video)

 

  

Flash Crash 2010 - VPRO documentary – 2011 (video, optional)

 

For discussion:

·        Next time, when a flash crash happens, can you think of a strategy to make money from this incident? Why or why not?

·        After the flash crash, the price will recover almost completely. So why the market is afraid of it. It is not a big deal, right?

 

 

 

Homework of the 1st week (due with the first mid-term exam):

1.     What is high frequency trading (HFT)? How does it work? 

2.     Do you anticipate rapid growth of HFT in US?  Shall the SEC ban HFT?

3.     What is spoofing? Why is it harmful to the market?

4.     What is flash crash? How does it make investors so worried? How can HFT trigger flash crash?

5.     After the flash crash, the price will recover almost completely. So why the market is afraid of it?

 

 

Tuesday-group 1

Thursday-group 2

Samuel

Baker

1

Kelly

Brassington

n/a

William

Burckley

1

Tyler

Cahill

1

Reed

Davis

1

Joshua

Hancock

1

Centraya

Kenny

1

Julia

Kolderman

1

 

Jack

Madren

2

Jennifer

Madrid

2

Sean

Martin

2

Maxwell

Moore

2

Devina

Petrone

2

Christopher

Raudez

2

Jacob

Sims

2

Nicholas

Zipperer

2

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The World of High-Frequency Algorithmic Trading

 

In the last decade, algorithmic trading (AT) and high-frequency trading (HFT) have come to dominate the trading world, particularly HFT. During 2009-2010, more than 60% of U.S. trading was attributed to HFT, though that percentage has declined in the last few years.1

 

 

Heres a look into the world of algorithmic and high-frequency trading: how they're related, their benefits and challenges, their main users and their current and future state.

 

 

High-Frequency Trading HFT Structure

First, note that HFT is a subset of algorithmic trading and, in turn, HFT includes Ultra HFT trading. Algorithms essentially work as middlemen between buyers and sellers, with HFT and Ultra HFT being a way for traders to capitalize on infinitesimal price discrepancies that might exist only for a minuscule period.

 

 

Computer-assisted rule-based algorithmic trading uses dedicated programs that make automated trading decisions to place orders. AT splits large-sized orders and places these split orders at different times and even manages trade orders after their submission.

 

Large sized-orders, usually made by pension funds or insurance companies, can have a severe impact on stock price levels. AT aims to reduce that price impact by splitting large orders into many small-sized orders, thereby offering traders some price advantage.

 

The algorithms also dynamically control the schedule of sending orders to the market. These algorithms read real-time high-speed data feeds, detect trading signals, identify appropriate price levels and then place trade orders once they identify a suitable opportunity. They can also detect arbitrage opportunities and can place trades based on trend following, news events, and even speculation.

 

 

High-frequency trading is an extension of algorithmic trading. It manages small-sized trade orders to be sent to the market at high speeds, often in milliseconds or microsecondsa millisecond is a thousandth of a second and a microsecond is a thousandth of a millisecond.

 

 

These orders are managed by high-speed algorithms which replicate the role of a market maker. HFT algorithms typically involve two-sided order placements (buy-low and sell-high) in an attempt to benefit from bid-ask spreads. HFT algorithms also try to sense any pending large-size orders by sending multiple small-sized orders and analyzing the patterns and time taken in trade execution. If they sense an opportunity, HFT algorithms then try to capitalize on large pending orders by adjusting prices to fill them and make profits.

 

 

Also, Ultra HFT is a further specialized stream of HFT. By paying an additional exchange fee, trading firms get access to see pending orders a split-second before the rest of the market does.

 

Profit Potential from HFT

Exploiting market conditions that can't be detected by the human eye, HFT algorithms bank on finding profit potential in the ultra-short time duration. One example is arbitrage between futures and ETFs on the same underlying index.

 

 

Automated Trading

In the U.S. markets, the SEC authorized automated electronic exchanges in 1998. Roughly a year later, HFT began, with trade execution time, at that time, being a few seconds. By 2010, this had been reduced to millisecondssee the speech by the Bank of England's Andrew Haldane's "Patience and finance"and today, one-hundredth of a microsecond is enough time for most HFT trade decisions and executions. Given ever-increasing computing power, working at nanosecond and picosecond frequencies may be achievable via HFT in the relatively near future.

 

Bloomberg reports that while in 2010, HFT "accounted for more than 60% of all U.S. equity volume, that proved to be a high-water mark. By 2013, that percentage had fallen to roughly 50%. Bloomberg further noted that where, in 2009, "high-frequency traders moved about 3.25 billion shares a day. In 2012, it was 1.6 billion a day and average profits have fallen from about a tenth of a penny per share to a twentieth of a penny.

 

HFT Participants

HFT trading ideally needs to have the lowest possible data latency (time-delays) and the maximum possible automation level. So participants prefer to trade in markets with high levels of automation and integration capabilities in their trading platforms. These include NASDAQ, NYSE, Direct Edge, and BATS.

 

HFT is dominated by proprietary trading firms and spans across multiple securities, including equities, derivatives, index funds, and ETFs, currencies and fixed income instruments. A 2011 Deutsche Bank report found that of then-current HFT participants, proprietary trading firms made up 48%, proprietary trading desks of multi-service broker-dealers were 46% and hedge funds about 6%. Major names in the space include proprietary trading firms like KWG Holdings (formed of the merger between Getco and Knight Capital) and the trading desks of large institutional firms like Citigroup (C), JP Morgan (JPM) and Goldman Sachs (GS).

 

HFT Infrastructure Needs

For high-frequency trading, participants need the following infrastructure in place:

 

·         High-speed computers, which need regular and costly hardware upgrades;

·         Co-location. That is, a typically high-cost facility that places your trading computers as close as possible to the exchange servers, to further reduce time delays;

·         Real-time data feeds, which are required to avoid even a microsecond's delay that may impact profits; and

·         Computer algorithms, which are the heart of AT and HFT.

 

Benefits of HFT

HFT is beneficial to traders, but does it help the overall market? Some overall market benefits that HFT supporters cite include:

 

·         Bid-ask spreads have reduced significantly due to HFT trading, which makes markets more efficient. Empirical evidence includes that after Canadian authorities in April 2012 imposed fees that discouraged HFT, studies suggested that the bid-ask spread rose by 9%," possibly due to declining HFT trades.7

·         HFT creates high liquidity and thus eases the effects of market fragmentation.

·         HFT assists in the price discovery and price formation process, as it is based on a large number of orders

 

Challenges Of HFT

Opponents of HFT argue that algorithms can be programmed to send hundreds of fake orders and cancel them in the next second. Such spoofing momentarily creates a false spike in demand/supply leading to price anomalies, which can be exploited by HFT traders to their advantage. In 2013, the SEC introduced the Market Information Data Analytics System (MIDAS), which screens multiple markets for data at millisecond frequencies to try and catch fraudulent activities like spoofing."

 

Other obstacles to HFT's growth are its high costs of entry, which include:

 

·         Algorithms development

·         Setting up high-speed trade execution platforms for timely trade execution

·         Building infrastructure that requires frequent high-cost upgrades

·         Subscription charges towards data feed

 

The HFT marketplace also has gotten crowded, with participants trying to get an edge over their competitors by constantly improving algorithms and adding to infrastructure. Due to this "arms race," it's getting more difficult for traders to capitalize on price anomalies, even if they have the best computers and top-end networks.

 

And the prospect of costly glitches is also scaring away potential participants. Some examples include the Flash Crash" of May 6, 2010, where HFT-triggered sell orders led to an impulsive drop of 600 points in the DJIA index.9 Then there's the case of Knight Capital, the then-king of HFT on NYSE. It installed new software on Aug 1, 2012, and accidentally bought and sold $7 billion worth of NYSE stocks at unfavorable prices.10 Knight was forced to settle its positions, costing it $440 million in one day and eroding 40% of the firms value. Acquired by another HFT firm, Getco, to form KCG Holdings, the merged entity still continues to struggle.

 

So, some major bottlenecks for HFT's future growth are its declining profit potential, high operational costs, the prospect of stricter regulations and the fact that there is no room for error, as losses can quickly run in the millions.

 

 

The Bottom Line

The growth of computer speed and algorithm development has created seemingly limitless possibilities in trading. But, AT and HFT are classic examples of rapid developments that, for years, outpaced regulatory regimes and allowed massive advantages to a relative handful of trading firms. While HFT may offer reduced opportunities in the future for traders in established markets like the U.S., some emerging markets could still be quite favorable for high-stakes HFT ventures.

 

 

 

 

 

 

 

 

Goldman Sachs says computerized trading may make next 'flash crash' worse

·         Goldman Sachs is worried the increasing dominance of computerized trading may cause more volatility during market downturns.

·         The firm says high-frequency trading machines may "withdraw liquidity" at the worst possible moment in the next financial crisis.

 | 

CNBC.com

 

Goldman Sachs is cautioning its clients that computerized trading may exacerbate the volatility of the next big market sell-off.

"One theory that has been proposed for why market fragility could be higher today is that because HFTs [high-frequency trading] supply liquidity without taking into account fundamental information, they are forced to withdraw liquidity during periods of market stress to avoid being adversely selected," Charles Himmelberg, co-head of global markets research at Goldman, said in a report Tuesday. "In our view, this at least raises the risk that as machines have replaced people, and speed has replaced capital, the inability of the market's liquidity providers to process complex information may lead to surprisingly large drops in liquidity when the next crisis hits."

Himmelberg noted the higher level of computerized trading has not been truly "stress tested" during the bull market since the financial crisis. He said the increasing incidents of volatility in various markets such as the VIX spike on Feb. 5, the 10-year Treasury bond on Oct. 15, 2014, and the British pound on Oct. 6, 2016, may be precursors of a bigger one to come.

"The rising frequency of 'flash crashes' across many major markets may be an important early warning sign that something is not quite right with the current state of trading liquidity," he said. "These warning signs plus the rapid growth of high-frequency trading (HFT) and its near-total dominance in many of the largest and most widely traded markets prompt us to more carefully consider the possibility (not necessarily the probability) that the long expansion accompanied by relatively low market volatility may have helped disguise an under-appreciated rise in 'market fragility.'"

The strategist said computerized trading is generally not backed by large levels of capital, which could drive the "collapse" of liquidity if the machines suffer any big losses during a significant market downturn.

"Future flash crashes may not end well," he warned. "The quality of trading liquidity for even the biggest, most heavily-traded markets should not be taken for granted."

 With reporting by CNBC's Michael Bloom.

 

 

The stock market halted trading Monday—here’s why younger investors shouldn’t panic

https://www.cnbc.com/2020/03/09/the-stock-market-halted-trading-younger-investors-shouldnt-panic.html

Published Mon, Mar 9 202011:30 AM EDTUpdated Tue, Mar 10 20209:25 AM EDT

Megan Leonhardt@MEGAN_LEONHARDT

 

The stock market opened on a rough note this week as fears that the coronavirus will continue to have widespread economic impact drove down stock prices. On Monday morning, the S&P 500 fell more than 7% at the open, triggering circuit breakers that led the New York Stock Exchange to halt all market trading for 15 minutes.

The plunge, which occurred just after the market opened, triggered what’s called a ‘circuit breaker’ that immediately halted trading. Basically, this is a fail-safe that’s built into the system to allow for a short cool down period.

“The market circuit breakers are designed to slow trading down for a few minutes, give investors the ability to understand what’s happening in the market, consume the information and make decisions based on market conditions,” New York Stock Exchange President Stacey Cunningham told CNBC’s Bob Pisani. “This is operating as it’s supposed to.”

The current system of circuit breakers has never been tripped. A revamped system was put in place in February 2013 after the last set failed to prevent the May 2010 flash crash.

 

During regular trading hours, a circuit breaker can be triggered in a few situations:

1.         If the S&P 500 drops 7%, then trading will pause for 15 minutes.

2.         If the S&P 500 declines 13% on or before 3:25 p.m. ET, then trading will be paused again for 15 minutes. If the drop occurs after 3:25 p.m., then there’s no halt.

3.         If the S&P 500 falls 20%, then trading will be suspended for the rest of the day.

 

Trading started back up at 9:49 a.m. ET and the S&P 500 continued to slide. Meanwhile, the Dow Jones Industrial Average, which tracks 30 stocks, fell 2,000 points, or 7.3%, at one point during morning trading. The Nasdaq, which features some of the market’s biggest technology names as well as an assortment of other companies, fell 6.9% during the same period. 

“The bull market’s 11-year birthday is today, but investors are not in a celebratory mood,” says Greg McBride, chartered financial analyst and chief financial analyst at Bankrate.com.

 

What it means for you

Over 66% of millennials have investments of some type. About a third of millennials invested in a taxable brokerage account in 2018, while another third invested in a retirement account, according to a study of over 1,800 millennials (ages 23 to 38) sponsored by the CFA Institute and the FINRA Investor Education Foundation.

If you’re part of that group, the roller coaster markets do have an impact on your investments, including your 401(k). But before you panic, keep in mind that market downturns are fairly common. Market pullbacks with declines of less than 20% have occurred over 100 times since 1946, according to investment firm Guggenheim Funds.

“Investing should never be about a moment in time; it should always be about a process over time,” Liz Ann Sonders, chief investment strategist at Charles Schwab, tells CNBC Make It.

That’s a nice way of saying: Don’t time the market. Most millennials (ages 24 to 39) have a long time horizon for their investments. Since there are likely decades before you retire, even if a recession hits tomorrow or next year, there’s plenty of time for your investments to bounce back. Recessions and market downturns are part of a normal, healthy market cycle.

2:19

NYSE President Stacey Cunningham explains why stock trading was halted for 15 minutes

The best course of action right now is to keep investing and making regular contributions to your 401(k). This routine influx of money into your investment accounts is a strategy that experts call dollar-cost averaging. It’s great for long-term investors because it takes emotion out of the equation and keeps you from selling out during market lows and buying in at market highs.

A 401(k) is actually a good place to invest amid market volatility, Sonders says. Typically, they’re structured in a way so that you’re buying on a regimented basis and many have the option to invest in target date funds, which have an automatic rebalancing process.

“As the uncertainty persists, the market frenzy will continue, perhaps for weeks, perhaps for months,” McBride says. “But long-term investors must think in terms of years or decades.”

Finally, just take a deep breath. Many millennials have strong “muscle memory” from their own involvement, or their parents’ experiences, with the market during the last financial crisis, Sonders says. Yet the reality is that that market event was not the rule; it was more on the exceptional end of the spectrum.

“Markets fall sharply, but can also rebound quickly,” McBride says. “No one knows when that comes and you don’t want to be sitting on the sidelines when that happens.”

 

The Work-From-Home Trader Who Shook Global Markets (Bloomberg) (optional)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Chapter 2 What is Money

 

Ppt

 

Part I What is Money?  

 

·         There is no single "correct" measure of the money supply: instead, there are several measures, classified along a spectrum or continuum between narrow and broad monetary aggregates.

•         Narrow measures include only the most liquid assets, the ones most easily used to spend (currency, checkable deposits). Broader measures add less liquid types of assets (certificates of deposit, etc.)

 

Type of money

M0

MB

M1

M2

M3

Notes and coins in circulation (outside Federal Reserve Banks and the vaults of depository institutions) (currency) 

Notes and coins in bank vaults (Vault cash)

Federal Reserve Bank credit (required reserves and excess reserves not physically present in banks)

Traveler’s checks of non-bank issuers

Demand deposits

Other checkable deposits (OCDs)

Savings deposits

Time deposits less than $100,000 and money market deposit accounts for individuals

Large time deposits, institutional money market funds, short-term repurchase and other larger liquid assets

All money market funds

·         M0: In some countries, such as the United Kingdom, M0 includes bank reserves, so M0 is referred to as the monetary base, or narrow money.

·         MB: is referred to as the monetary base or total currency.  This is the base from which other forms of money (like checking deposits, listed below) are created and is traditionally the most liquid measure of the money supply.

·         M1: Bank reserves are not included in M1. (M1 and Components @ Fed St. Louise website)

·         M2: Represents M1 and "close substitutes" for M1. M2 is a broader classification of money than M1. M2 is a key economic indicator used to forecast inflation. (M2 and components @ Fed St. Louise website)

·         M3: M2 plus large and long-term deposits. Since 2006, M3 is no longer published by the US central bank. However, there are still estimates produced by various private institutions. (M3 and components at Fed St. Louise website)

·         

 FYI: Fed balance sheet

 

Lets watch this money supply video: Khan academy money supply M0, M1, M2 (video)

 

Draw Me The Economy: Money Supply (video)

 

 

For discussion:

·         What could happen if we increase money supply?

·          What about reduce money supply?

·         What are the possible ways to reduce money supply?

·         Among M0, M1, M2, M3, which one is the correct measure of money?

·         Why M2 is >> M0?

·         Why does M2 increase much faster than M1? Does it has any impact on you?

 

For more information, please visit http://www.data360.org/report_slides.aspx?Print_Group_Id=168

 

https://fred.stlouisfed.org/categories/24

 

M0, M1, and M2 Over Time

The top three graphs show M0, M1, and M2 money supply indicators over the past 40 odd years. The bottom three graphs show M0, M1, and M2 money supply indicators from June 2010. We see that the money supply has increased steadily over the years. In particular, the increase in money supply has been greatest in the recession years. This correlates to attempts made by the government to stimulate the economy and follow an expansionary monetary policy.

 

     image010.jpgimage009.jpg

 

 

For discussion:

·         Among M0, M1, and M2, which one is used as a measure for money supply in US?

·         Why is M2 multiple times of Mo?

·         What are the expected consequences resulted from a big increase in money supply?

·         Do you think that US$ will devalue in the near future?

·         What do you suggest in terms of investment? Bitcoin? Commodity? Stock? Bond? Why?

 

 

 

Summary:

Money Supply M2 in the United States increased to 14872.10 USD Billion in July from 14755.10 USD Billion in June of 2019. oney Supply M2 in the United States averaged 4121.70 USD Billion from 1959 until 2019, reaching an all time high of 14872.10 USD Billion in July of 2019 and a record low of 286.60 USD Billion in January of 1959.

 

From https://tradingeconomics.com/united-states/money-supply-m2

 

image007.jpg

Actual

Previous

Highest

Lowest

Dates

Unit

Frequency

18326.80

18357.30

18357.30

286.60

1959 - 2020

USD Billion

Monthly

Current Prices, SA

 

United States Money

Last

Previous

Highest

Lowest

Unit

Interest Rate

0.25

0.25

20.00

0.25

percent

[+]

Interbank Rate

0.25

0.25

10.63

0.22

percent

[+]

Money Supply M0

4700401.00

5001978.00

5149527.00

48362.00

USD Million

[+]

Money Supply M1

5328.60

5249.90

5328.60

138.90

USD Billion

[+]

Money Supply M2

18326.80

18357.30

18357.30

286.60

USD Billion

[+]

 Central Bank Balance Sheet

6911119.00

6902265.00

7113208.00

672444.00

USD Million

[+]

Banks Balance Sheet

20039200.00

19971600.00

20342894.00

697581.70

USD Million

[+]

Foreign Exchange Reserves

133890.00

132239.00

153075.00

12128.00

USD Million

[+]

Loans to Private Sector

2822.46

2900.06

3030.13

13.65

USD Billion

[+]

Foreign Bond Investment

28900.00

-27719.00

118012.00

-299126.00

USD Million

[+]

Private Debt to GDP

220.20

216.20

224.50

162.90

percent

[+]

Repo Rate

0.11

0.12

6.94

-0.01

[+]

 

 

 

M2 of other countries

 

Country

Last

Previous

Range

Argentina

2043886.20

Jun/19

1949229

2123331 : 712

ARS Million

Brazil

2882184.74

Jul/19

2878391

2882185 : 0.01

BRL Million

Canada

1737081.00

Jul/19

1721566

1737081 : 25523

CAD Million

China

193550.00

Aug/19

191941

193550 : 5840

CNY Billion

Euro Area

12130349.00

Jul/19

12056341

12130349 : 1070365

EUR Million

France

2279384.00

Jul/19

2256216

2279384 : 263286

EUR Million

Germany

3111.10

Jul/19

3100

3111 : 34.4

EUR Billion

India

36941.69

Aug/19

37154

37404 : 1127

INR Billion

Indonesia

5937500.00

Jul/19

5918515

5937500 : 5156

IDR Billion

Italy

1595700.00

Jun/19

1576757

1595700 : 132635

EUR Million

Japan

1030974.80

Jul/19

1029615

1030975 : 8404

JPY Billion

Mexico

8967387851.00

Jul/19

8938303088

10147459591 : 15370409

MXN Thousand

Netherlands

874900.00

Jul/19

871121

877560 : 102486

EUR Million

Russia

47351.00

Jul/19

47348

47351 : 1090

RUB Billion

Saudi Arabia

1693334.00

Jul/19

1693532

1693532 : 169395

SAR Million

Singapore

620413.00

Jul/19

620328

622406 : 6182

SGD Million

South Africa

2965855.00

Jul/19

2905091

2965855 : 2887

ZAR Million

South Korea

2790153.00

Jun/19

2778413

2790153 : 591

KRW Billion

Spain

1226327.00

Jul/19

1246563

1246563 : 294870

EUR Million

Switzerland

1028773.00

Jul/19

1026714

1030195 : 198227

CHF Million

Turkey

2266821545.10

Aug/19

2178802052

2266821545 : 236620702

TRY Thousand

United Kingdom

2441750.00

Jul/19

2437574

2441750 : 167427

GBP Million

United States

14872.10

Jul/19

14755

14872 : 287

USD Billion

 

For discussion:

Money supplies have increased rapidly in every country. Why? Does it make any sense? What are be the possible consequences, in your opinion?

 

From https://www.federalreserve.gov/releases/h6/current/default.htm

Table 1

Money Stock Measures. Billions of dollars.

Date

Seasonally adjusted

Not seasonally adjusted

M1 1

M2 2

M1 1

M2 2

Aug. 2018

3,686.4

14,197.0

3,686.2

14,171.6

Sept. 2018

3,704.0

14,228.5

3,671.6

14,207.2

Oct. 2018

3,719.1

14,235.4

3,718.5

14,209.7

Nov. 2018

3,698.1

14,245.4

3,676.6

14,263.2

Dec. 2018

3,746.4

14,351.7

3,796.8

14,456.5

Jan. 2019

3,740.4

14,434.6

3,745.4

14,433.6

Feb. 2019

3,759.6

14,464.3

3,702.0

14,411.4

Mar. 2019

3,729.8

14,511.8

3,753.8

14,582.9

Apr. 2019

3,780.9

14,558.7

3,819.8

14,634.3

May 2019

3,792.4

14,654.3

3,787.7

14,585.2

June 2019

3,832.8

14,782.6

3,828.1

14,745.4

July 2019

3,858.1

14,862.1

3,860.7

14,824.9

Aug. 2019

3,853.2

14,933.3

3,847.1

14,906.1

Sept. 2019

3,903.0

15,022.9

3,874.3

14,997.0

Oct. 2019

3,922.8

15,149.8

3,921.6

15,123.8

Nov. 2019

3,947.4

15,251.2

3,922.2

15,270.4

Dec. 2019

3,976.9

15,307.1

4,041.2

15,422.8

Jan. 2020

3,975.0

15,402.1

3,980.0

15,405.2

Feb. 2020

4,003.0

15,446.9

3,939.6

15,392.7

Mar. 2020

4,256.4

15,989.9

4,287.4

16,066.4

Apr. 2020

4,797.2

17,020.8

4,847.6

17,113.6

May 2020

5,031.6

17,870.4

5,012.9

17,779.0

June 2020

5,209.6

18,166.7

5,212.4

18,118.7

July 2020

5,329.1

18,327.0

5,330.5

18,278.8

Make Full Screen

Percent change at seasonally adjusted annual rates

M1

M2

3 Months from Apr. 2020 TO July 2020

44.4

30.7

6 Months from Jan. 2020 TO July 2020

68.1

38.0

12 Months from July 2019 TO July 2020

38.1

23.3

 

Table 2

Money Stock Measures. Billions of dollars.

Period ending

Seasonally adjusted

Not seasonally adjusted

M1

M2

M1

M2

13-week
average

4-week
average

week
average

13-week
average

4-week
average

week
average

13-week
average

4-week
average

week
average

13-week
average

4-week
average

week
average

May 18, 2020

4,547.4

4,989.5

5,032.7

16,619.1

17,683.9

17,909.6

4,551.9

4,972.4

4,948.1

16,651.5

17,599.6

17,821.9

May 25, 2020

4,631.7

5,032.2

5,066.0

16,811.8

17,816.9

17,938.6

4,643.0

4,977.9

5,130.8

16,840.6

17,715.0

17,797.0

June 1, 2020

4,707.6

5,039.8

5,013.2

17,001.1

17,910.3

17,973.4

4,733.2

5,032.1

5,252.6

17,027.2

17,809.4

17,928.9

June 8, 2020

4,786.9

5,051.2

5,092.8

17,193.0

17,971.1

18,062.8

4,811.4

5,072.4

4,957.9

17,212.1

17,897.3

18,041.3

June 15, 2020

4,868.4

5,089.2

5,184.9

17,378.7

18,028.5

18,139.0

4,886.5

5,093.9

5,034.2

17,388.7

17,974.2

18,129.5

June 22, 2020

4,943.5

5,144.9

5,288.5

17,539.1

18,103.2

18,237.4

4,956.8

5,133.7

5,290.1

17,535.9

18,055.5

18,122.3

June 29, 2020

5,003.5

5,214.5

5,291.9

17,669.9

18,168.2

18,233.5

5,015.8

5,205.8

5,541.1

17,654.8

18,117.3

18,175.9

July 6, 2020

5,050.6

5,241.6

5,200.9

17,803.0

18,233.9

18,325.7

5,062.3

5,269.6

5,213.0

17,775.7

18,196.6

18,358.5

July 13, 2020

5,094.4

5,266.5

5,284.7

17,931.6

18,296.4

18,388.9

5,100.4

5,290.2

5,116.7

17,885.8

18,256.2

18,368.1

July 20, 2020

5,132.9

5,281.0

5,346.4

18,027.2

18,316.6

18,318.3

5,133.9

5,296.5

5,315.1

17,968.6

18,293.7

18,272.2

July 27, 2020

5,168.7

5,298.2

5,360.9

18,094.8

18,329.5

18,285.2

5,164.3

5,287.2

5,504.0

18,030.9

18,286.1

18,145.5

Aug. 3, 2020

5,207.6

5,370.1

5,488.4

18,145.4

18,312.7

18,258.4

5,209.3

5,389.1

5,620.4

18,085.6

18,261.8

18,261.3

Aug. 10, 2020

5,235.7

5,402.2

5,413.0

18,190.2

18,316.1

18,402.4

5,237.3

5,400.1

5,161.0

18,135.1

18,253.2

18,333.7

 

Table 3

Seasonally Adjusted Components of M1. Billions of dollars.

Date

Currency 1

Traveler's checks 2

Demand deposits 3

Other checkable deposits

At commercial banks 4

At thrift institutions 5

Total

Month

Mar. 2019

1,637.2

 

1,458.3

342.8

291.5

634.3

Apr. 2019

1,645.2

 

1,487.9

353.6

294.2

647.8

May 2019

1,650.8

 

1,493.8

353.7

294.1

647.8

June 2019

1,657.8

 

1,527.1

351.6

296.3

647.9

July 2019

1,666.6

 

1,534.6

361.5

295.4

656.9

Aug. 2019

1,674.3

 

1,521.1

358.1

299.7

657.8

Sept. 2019

1,685.0

 

1,553.8

364.4

299.8

664.2

Oct. 2019

1,693.4

 

1,562.8

365.0

301.5

666.5

Nov. 2019

1,703.3

 

1,579.7

362.5

301.8

664.3

Dec. 2019

1,710.9

 

1,592.0

367.2

306.8

674.0

Jan. 2020

1,720.7

 

1,580.6

364.8

309.0

673.8

Feb. 2020

1,723.5

 

1,602.0

367.9

309.7

677.6

Mar. 2020

1,744.6

 

1,813.3

377.2

321.2

698.5

Apr. 2020

1,780.3

 

2,032.0

370.0

615.0

985.0

May 2020

1,818.5

 

2,150.6

408.3

654.1

1,062.4

June 2020

1,855.9

 

2,211.4

469.9

672.4

1,142.3

July 2020

1,884.2

 

2,251.1

482.0

711.8

1,193.8

 

Week ending

June 15, 2020

1,853.3

 

2,179.2

474.2

678.3

1,152.5

June 22, 2020

1,860.3

 

2,292.3

466.5

669.4

1,135.9

June 29, 2020

1,866.3

 

2,283.7

471.6

670.4

1,142.0

July 6, 2020

1,870.0

 

2,165.1

467.5

698.3

1,165.8

July 13, 2020

1,878.5

 

2,192.4

486.6

727.2

1,213.8

July 20, 2020

1,885.0

 

2,255.9

488.9

716.6

1,205.5

July 27, 2020

1,892.3

 

2,281.3

480.1

707.3

1,187.4

Aug. 3, 2020

1,899.5

 

2,399.2

485.5

704.3

1,189.8

Aug. 10, 2020

1,906.2

 

2,289.0

484.7

733.2

1,217.9

 

Table 4

Seasonally Adjusted Components of Non-M1 M2. Billions of dollars.

Date

Savings deposits 1

Small-denomination time deposits 2

Retail
money funds 3

Total
non-M1 M2

Memorandum:
Institutional
money funds 4

At commercial
banks

At thrift
institutions

Total

At commercial
banks

At thrift
institutions

Total

Month

Mar. 2019

7,981.3

1,344.1

9,325.4

470.5

116.9

587.3

869.3

10,781.9

1,929.5

Apr. 2019

7,961.5

1,336.9

9,298.4

479.2

119.1

598.3

881.0

10,777.8

1,942.1

May 2019

8,029.7

1,343.5

9,373.2

479.7

120.3

600.0

888.7

10,861.9

1,974.4

June 2019

8,100.0

1,341.1

9,441.1

484.6

123.1

607.7

901.0

10,949.8

2,024.3

July 2019

8,138.7

1,338.7

9,477.3

482.8

124.3

607.1

919.5

11,004.0

2,084.8

Aug. 2019

8,203.4

1,338.7

9,542.1

480.8

124.8

605.5

932.6

11,080.2

2,125.5

Sept. 2019

8,228.6

1,340.1

9,568.7

476.8

125.3

602.1

949.1

11,119.9

2,159.6

Oct. 2019

8,308.0

1,348.5

9,656.5

471.2

125.5

596.7

973.8

11,227.1

2,203.7

Nov. 2019

8,378.2

1,346.5

9,724.7

465.2

125.2

590.4

988.7

11,303.8

2,240.5

Dec. 2019

8,418.2

1,347.7

9,765.9

458.7

124.2

582.8

981.5

11,330.2

2,251.8

Jan. 2020

8,527.2

1,348.5

9,875.8

451.0

117.6

568.5

982.8

11,427.1

2,270.0

Feb. 2020

8,566.7

1,357.8

9,924.5

429.5

109.5

539.0

980.4

11,443.9

2,262.3

Mar. 2020

8,802.7

1,399.5

10,202.3

406.7

101.6

508.3

1,022.9

11,733.5

2,489.1

Apr. 2020

9,444.1

1,194.7

10,638.8

391.0

94.4

485.4

1,099.3

12,223.6

3,101.2

May 2020

9,978.1

1,259.6

11,237.7

370.5

91.9

462.4

1,138.7

12,838.8

3,323.7

June 2020

10,103.7

1,288.4

11,392.1

340.1

88.2

428.3

1,136.7

12,957.1

3,245.0

July 2020

10,193.4

1,290.9

11,484.3

308.9

85.8

394.6

1,119.1

12,997.9

3,155.1

 

Week ending

June 15, 2020

10,117.9

1,270.0

11,387.9

343.9

88.6

432.4

1,133.7

12,954.1

3,234.9

June 22, 2020

10,087.0

1,300.4

11,387.4

337.0

87.9

424.9

1,136.6

12,948.9

3,237.5

June 29, 2020

10,075.4

1,311.8

11,387.3

330.0

86.9

416.9

1,137.4

12,941.6

3,239.7

July 6, 2020

10,294.2

1,291.2

11,585.4

321.8

85.7

407.5

1,132.0

13,124.8

3,198.4

July 13, 2020

10,304.4

1,273.8

11,578.2

315.1

85.6

400.7

1,125.4

13,104.3

3,192.0

July 20, 2020

10,179.6

1,284.9

11,464.5

308.0

85.8

393.8

1,113.5

12,971.8

3,113.6

July 27, 2020

10,117.3

1,308.1

11,425.4

301.0

86.6

387.6

1,111.3

12,924.3

3,139.8

Aug. 3, 2020

9,977.7

1,303.0

11,280.7

292.6

84.7

377.3

1,111.9

12,770.0

3,125.2

Aug. 10, 2020

10,228.3

1,285.3

11,513.7

286.3

84.4

370.7

1,105.0

12,989.4

3,111.3

Beyond Bitcoin bubble – New York Times (FYI only)

https://www.nytimes.com/2018/01/16/magazine/beyond-the-bitcoin-bubble.html

 

The sequence of words is meaningless: a random array strung together by an algorithm let loose in an English dictionary. What makes them valuable is that they’ve been generated exclusively for me, by a software tool called MetaMask. In the lingo of cryptography, they’re known as my seed phrase. They might read like an incoherent stream of consciousness, but these words can be transformed into a key that unlocks a digital bank account, or even an online identity. It just takes a few more steps.

On the screen, I’m instructed to keep my seed phrase secure: Write it down, or keep it in a secure place on your computer. I scribble the 12 words onto a notepad, click a button and my seed phrase is transformed into a string of 64 seemingly patternless characters:

1b0be2162cedb2744d016943bb14e71de6af95a63af3790d6b41b1e719dc5c66

This is what’s called a “private key” in the world of cryptography: a way of proving identity, in the same, limited way that real-world keys attest to your identity when you unlock your front door. My seed phrase will generate that exact sequence of characters every time, but there’s no known way to reverse-engineer the original phrase from the key, which is why it is so important to keep the seed phrase in a safe location.

That private key number is then run through two additional transformations, creating a new string:

0x6c2ecd6388c550e8d99ada34a1cd55bedd052ad9

That string is my address on the Ethereum blockchain.

Ethereum belongs to the same family as the cryptocurrency Bitcoin, whose value has increased more than 1,000 percent in just the past year. Ethereum has its own currencies, most notably Ether, but the platform has a wider scope than just money. You can think of my Ethereum address as having elements of a bank account, an email address and a Social Security number. For now, it exists only on my computer as an inert string of nonsense, but the second I try to perform any kind of transaction — say, contributing to a crowdfunding campaign or voting in an online referendum — that address is broadcast out to an improvised worldwide network of computers that tries to verify the transaction. The results of that verification are then broadcast to the wider network again, where more machines enter into a kind of competition to perform complex mathematical calculations, the winner of which gets to record that transaction in the single, canonical record of every transaction ever made in the history of Ethereum. Because those transactions are registered in a sequence of “blocks” of data, that record is called the blockchain.

The whole exchange takes no more than a few minutes to complete. From my perspective, the experience barely differs from the usual routines of online life. But on a technical level, something miraculous is happening — something that would have been unimaginable just a decade ago. I’ve managed to complete a secure transaction without any of the traditional institutions that we rely on to establish trust. No intermediary brokered the deal; no social-media network captured the data from my transaction to better target its advertising; no credit bureau tracked the activity to build a portrait of my financial trustworthiness.

And the platform that makes all this possible? No one owns it. There are no venture investors backing Ethereum Inc., because there is no Ethereum Inc. As an organizational form, Ethereum is far closer to a democracy than a private corporation. No imperial chief executive calls the shots. You earn the privilege of helping to steer Ethereum’s ship of state by joining the community and doing the work. Like Bitcoin and most other blockchain platforms, Ethereum is more a swarm than a formal entity. Its borders are porous; its hierarchy is deliberately flattened.

Oh, one other thing: Some members of that swarm have already accumulated a paper net worth in the billions from their labors, as the value of one “coin” of Ether rose from $8 on Jan. 1, 2017, to $843 exactly one year later.

You may be inclined to dismiss these transformations. After all, Bitcoin and Ether’s runaway valuation looks like a case study in irrational exuberance. And why should you care about an arcane technical breakthrough that right now doesn’t feel all that different from signing in to a website to make a credit card payment?

‘The Bitcoin bubble may ultimately turn out to be a distraction from the true significance of the blockchain.’

But that dismissal would be shortsighted. If there’s one thing we’ve learned from the recent history of the internet, it’s that seemingly esoteric decisions about software architecture can unleash profound global forces once the technology moves into wider circulation. If the email standards adopted in the 1970s had included public-private key cryptography as a default setting, we might have avoided the cataclysmic email hacks that have afflicted everyone from Sony to John Podesta, and millions of ordinary consumers might be spared routinized identity theft. If Tim Berners-Lee, the inventor of the World Wide Web, had included a protocol for mapping our social identity in his original specs, we might not have Facebook.

The true believers behind blockchain platforms like Ethereum argue that a network of distributed trust is one of those advances in software architecture that will prove, in the long run, to have historic significance. That promise has helped fuel the huge jump in cryptocurrency valuations. But in a way, the Bitcoin bubble may ultimately turn out to be a distraction from the true significance of the blockchain. The real promise of these new technologies, many of their evangelists believe, lies not in displacing our currencies but in replacing much of what we now think of as the internet, while at the same time returning the online world to a more decentralized and egalitarian system. If you believe the evangelists, the blockchain is the future. But it is also a way of getting back to the internet’s roots.

Once the inspiration for utopian dreams of infinite libraries and global connectivity, the internet has seemingly become, over the past year, a universal scapegoat: the cause of almost every social ill that confronts us. Russian trolls destroy the democratic system with fake news on Facebook; hate speech flourishes on Twitter and Reddit; the vast fortunes of the geek elite worsen income equality. For many of us who participated in the early days of the web, the last few years have felt almost postlapsarian. The web had promised a new kind of egalitarian media, populated by small magazines, bloggers and self-organizing encyclopedias; the information titans that dominated mass culture in the 20th century would give way to a more decentralized system, defined by collaborative networks, not hierarchies and broadcast channels. The wider culture would come to mirror the peer-to-peer architecture of the internet itself. The web in those days was hardly a utopia — there were financial bubbles and spammers and a thousand other problems — but beneath those flaws, we assumed, there was an underlying story of progress.

Last year marked the point at which that narrative finally collapsed. The existence of internet skeptics is nothing new, of course; the difference now is that the critical voices increasingly belong to former enthusiasts. “We have to fix the internet,” Walter Isaacson, Steve Jobs’s biographer, wrote in an essay published a few weeks after Donald Trump was elected president. “After 40 years, it has begun to corrode, both itself and us.” The former Google strategist James Williams told The Guardian: “The dynamics of the attention economy are structurally set up to undermine the human will.” In a blog post, Brad Burnham, a managing partner at Union Square Ventures, a top New York venture-capital firm, bemoaned the collateral damage from the quasi monopolies of the digital age: “Publishers find themselves becoming commodity content suppliers in a sea of undifferentiated content in the Facebook news feed. Websites see their fortunes upended by small changes in Google’s search algorithms. And manufacturers watch helplessly as sales dwindle when Amazon decides to source products directly in China and redirect demand to their own products.” (Full disclosure: Burnham’s firm invested in a company I started in 2006; we have had no financial relationship since it sold in 2011.) Even Berners-Lee, the inventor of the web itself, wrote a blog post voicing his concerns that the advertising-based model of social media and search engines creates a climate where “misinformation, or ‘fake news,’ which is surprising, shocking or designed to appeal to our biases, can spread like wildfire.”

For most critics, the solution to these immense structural issues has been to propose either a new mindfulness about the dangers of these tools — turning off our smartphones, keeping kids off social media — or the strong arm of regulation and antitrust: making the tech giants subject to the same scrutiny as other industries that are vital to the public interest, like the railroads or telephone networks of an earlier age. Both those ideas are commendable: We probably should develop a new set of habits governing how we interact with social media, and it seems entirely sensible that companies as powerful as Google and Facebook should face the same regulatory scrutiny as, say, television networks. But those interventions are unlikely to fix the core problems that the online world confronts. After all, it was not just the antitrust division of the Department of Justice that challenged Microsoft’s monopoly power in the 1990s; it was also the emergence of new software and hardware — the web, open-source software and Apple products — that helped undermine Microsoft’s dominant position.

The blockchain evangelists behind platforms like Ethereum believe that a comparable array of advances in software, cryptography and distributed systems has the ability to tackle today’s digital problems: the corrosive incentives of online advertising; the quasi monopolies of Facebook, Google and Amazon; Russian misinformation campaigns. If they succeed, their creations may challenge the hegemony of the tech giants far more effectively than any antitrust regulation. They even claim to offer an alternative to the winner-take-all model of capitalism than has driven wealth inequality to heights not seen since the age of the robber barons.

That remedy is not yet visible in any product that would be intelligible to an ordinary tech consumer. The only blockchain project that has crossed over into mainstream recognition so far is Bitcoin, which is in the middle of a speculative bubble that makes the 1990s internet I.P.O. frenzy look like a neighborhood garage sale. And herein lies the cognitive dissonance that confronts anyone trying to make sense of the blockchain: the potential power of this would-be revolution is being actively undercut by the crowd it is attracting, a veritable goon squad of charlatans, false prophets and mercenaries. Not for the first time, technologists pursuing a vision of an open and decentralized network have found themselves surrounded by a wave of opportunists looking to make an overnight fortune. The question is whether, after the bubble has burst, the very real promise of the blockchain can endure.

To some students of modern technological history, the internet’s fall from grace follows an inevitable historical script. As Tim Wu argued in his 2010 book, “The Master Switch,” all the major information technologies of the 20th century adhered to a similar developmental pattern, starting out as the playthings of hobbyists and researchers motivated by curiosity and community, and ending up in the hands of multinational corporations fixated on maximizing shareholder value. Wu calls this pattern the Cycle, and on the surface at least, the internet has followed the Cycle with convincing fidelity. The internet began as a hodgepodge of government-funded academic research projects and side-hustle hobbies. But 20 years after the web first crested into the popular imagination, it has produced in Google, Facebook and Amazon — and indirectly, Apple — what may well be the most powerful and valuable corporations in the history of capitalism.

Blockchain advocates don’t accept the inevitability of the Cycle. The roots of the internet were in fact more radically open and decentralized than previous information technologies, they argue, and had we managed to stay true to those roots, it could have remained that way. The online world would not be dominated by a handful of information-age titans; our news platforms would be less vulnerable to manipulation and fraud; identity theft would be far less common; advertising dollars would be distributed across a wider range of media properties.

To understand why, it helps to think of the internet as two fundamentally different kinds of systems stacked on top of each other, like layers in an archaeological dig. One layer is composed of the software protocols that were developed in the 1970s and 1980s and hit critical mass, at least in terms of audience, in the 1990s. (A protocol is the software version of a lingua franca, a way that multiple computers agree to communicate with one another. There are protocols that govern the flow of the internet’s raw data, and protocols for sending email messages, and protocols that define the addresses of web pages.) And then above them, a second layer of web-based services — Facebook, Google, Amazon, Twitter — that largely came to power in the following decade.

The first layer — call it InternetOne — was founded on open protocols, which in turn were defined and maintained by academic researchers and international-standards bodies, owned by no one. In fact, that original openness continues to be all around us, in ways we probably don’t appreciate enough. Email is still based on the open protocols POP, SMTP and IMAP; websites are still served up using the open protocol HTTP; bits are still circulated via the original open protocols of the internet, TCP/IP. You don’t need to understand anything about how these software conventions work on a technical level to enjoy their benefits. The key characteristic they all share is that anyone can use them, free of charge. You don’t need to pay a licensing fee to some corporation that owns HTTP if you want to put up a web page; you don’t have to sell a part of your identity to advertisers if you want to send an email using SMTP. Along with Wikipedia, the open protocols of the internet constitute the most impressive example of commons-based production in human history.

To see how enormous but also invisible the benefits of such protocols have been, imagine that one of those key standards had not been developed: for instance, the open standard we use for defining our geographic location, GPS. Originally developed by the United States military, the Global Positioning System was first made available for civilian use during the Reagan administration. For about a decade, it was largely used by the aviation industry, until individual consumers began to use it in car navigation systems. And now we have smartphones that can pick up a signal from GPS satellites orbiting above us, and we use that extraordinary power to do everything from locating nearby restaurants to playing Pokémon Go to coordinating disaster-relief efforts.

But what if the military had kept GPS out of the public domain? Presumably, sometime in the 1990s, a market signal would have gone out to the innovators of Silicon Valley and other tech hubs, suggesting that consumers were interested in establishing their exact geographic coordinates so that those locations could be projected onto digital maps. There would have been a few years of furious competition among rival companies, who would toss their own proprietary satellites into orbit and advance their own unique protocols, but eventually the market would have settled on one dominant model, given all the efficiencies that result from a single, common way of verifying location. Call that imaginary firm GeoBook. Initially, the embrace of GeoBook would have been a leap forward for consumers and other companies trying to build location awareness into their hardware and software. But slowly, a darker narrative would have emerged: a single private corporation, tracking the movements of billions of people around the planet, building an advertising behemoth based on our shifting locations. Any start-up trying to build a geo-aware application would have been vulnerable to the whims of mighty GeoBook. Appropriately angry polemics would have been written denouncing the public menace of this Big Brother in the sky.

But none of that happened, for a simple reason. Geolocation, like the location of web pages and email addresses and domain names, is a problem we solved with an open protocol. And because it’s a problem we don’t have, we rarely think about how beautifully GPS does work and how many different applications have been built on its foundation.

The open, decentralized web turns out to be alive and well on the InternetOne layer. But since we settled on the World Wide Web in the mid-’90s, we’ve adopted very few new open-standard protocols. The biggest problems that technologists tackled after 1995 — many of which revolved around identity, community and payment mechanisms — were left to the private sector to solve. This is what led, in the early 2000s, to a powerful new layer of internet services, which we might call InternetTwo.

For all their brilliance, the inventors of the open protocols that shaped the internet failed to include some key elements that would later prove critical to the future of online culture. Perhaps most important, they did not create a secure open standard that established human identity on the network. Units of information could be defined — pages, links, messages — but people did not have their own protocol: no way to define and share your real name, your location, your interests or (perhaps most crucial) your relationships to other people online.

This turns out to have been a major oversight, because identity is the sort of problem that benefits from one universally recognized solution. It’s what Vitalik Buterin, a founder of Ethereum, describes as “base-layer” infrastructure: things like language, roads and postal services, platforms where commerce and competition are actually assisted by having an underlying layer in the public domain. Offline, we don’t have an open market for physical passports or Social Security numbers; we have a few reputable authorities — most of them backed by the power of the state — that we use to confirm to others that we are who we say we are. But online, the private sector swooped in to fill that vacuum, and because identity had that characteristic of being a universal problem, the market was heavily incentivized to settle on one common standard for defining yourself and the people you know.

The self-reinforcing feedback loops that economists call “increasing returns” or “network effects” kicked in, and after a period of experimentation in which we dabbled in social-media start-ups like Myspace and Friendster, the market settled on what is essentially a proprietary standard for establishing who you are and whom you know. That standard is Facebook. With more than two billion users, Facebook is far larger than the entire internet at the peak of the dot-com bubble in the late 1990s. And that user growth has made it the world’s sixth-most-valuable corporation, just 14 years after it was founded. Facebook is the ultimate embodiment of the chasm that divides InternetOne and InternetTwo economies. No private company owned the protocols that defined email or GPS or the open web. But one single corporation owns the data that define social identity for two billion people today — and one single person, Mark Zuckerberg, holds the majority of the voting power in that corporation.

If you see the rise of the centralized web as an inevitable turn of the Cycle, and the open-protocol idealism of the early web as a kind of adolescent false consciousness, then there’s less reason to fret about all the ways we’ve abandoned the vision of InternetOne. Either we’re living in a fallen state today and there’s no way to get back to Eden, or Eden itself was a kind of fantasy that was always going to be corrupted by concentrated power. In either case, there’s no point in trying to restore the architecture of InternetOne; our only hope is to use the power of the state to rein in these corporate giants, through regulation and antitrust action. It’s a variation of the old Audre Lorde maxim: “The master’s tools will never dismantle the master’s house.” You can’t fix the problems technology has created for us by throwing more technological solutions at it. You need forces outside the domain of software and servers to break up cartels with this much power.

But the thing about the master’s house, in this analogy, is that it’s a duplex. The upper floor has indeed been built with tools that cannot be used to dismantle it. But the open protocols beneath them still have the potential to build something better.

One of the most persuasive advocates of an open-protocol revival is Juan Benet, a Mexican-born programmer now living on a suburban side street in Palo Alto, Calif., in a three-bedroom rental that he shares with his girlfriend and another programmer, plus a rotating cast of guests, some of whom belong to Benet’s organization, Protocol Labs. On a warm day in September, Benet greeted me at his door wearing a black Protocol Labs hoodie. The interior of the space brought to mind the incubator/frat house of HBO’s “Silicon Valley,” its living room commandeered by an array of black computer monitors. In the entrance hallway, the words “Welcome to Rivendell” were scrawled out on a whiteboard, a nod to the Elven city from “Lord of the Rings.” “We call this house Rivendell,” Benet said sheepishly. “It’s not a very good Rivendell. It doesn’t have enough books, or waterfalls, or elves.”

Benet, who is 29, considers himself a child of the first peer-to-peer revolution that briefly flourished in the late 1990s and early 2000s, driven in large part by networks like BitTorrent that distributed media files, often illegally. That initial flowering was in many ways a logical outgrowth of the internet’s decentralized, open-protocol roots. The web had shown that you could publish documents reliably in a commons-based network. Services like BitTorrent or Skype took that logic to the next level, allowing ordinary users to add new functionality to the internet: creating a distributed library of (largely pirated) media, as with BitTorrent, or helping people make phone calls over the internet, as with Skype.

‘We’re not trying to replace the U.S. government. It’s not meant to be a real currency; it’s meant to be a pseudo-currency inside this world.’

Sitting in the living room/office at Rivendell, Benet told me that he thinks of the early 2000s, with the ascent of Skype and BitTorrent, as “the ‘summer’ of peer-to-peer” — its salad days. “But then peer-to-peer hit a wall, because people started to prefer centralized architectures,” he said. “And partly because the peer-to-peer business models were piracy-driven.” A graduate of Stanford’s computer-science program, Benet talks in a manner reminiscent of Elon Musk: As he speaks, his eyes dart across an empty space above your head, almost as though he’s reading an invisible teleprompter to find the words. He is passionate about the technology Protocol Labs is developing, but also keen to put it in a wider context. For Benet, the shift from distributed systems to more centralized approaches set in motion changes that few could have predicted. “The rules of the game, the rules that govern all of this technology, matter a lot,” he said. “The structure of what we build now will paint a very different picture of the way things will be five or 10 years in the future.” He continued: “It was clear to me then that peer-to-peer was this extraordinary thing. What was not clear to me then was how at risk it is. It was not clear to me that you had to take up the baton, that it’s now your turn to protect it.”

Protocol Labs is Benet’s attempt to take up that baton, and its first project is a radical overhaul of the internet’s file system, including the basic scheme we use to address the location of pages on the web. Benet calls his system IPFS, short for InterPlanetary File System. The current protocol — HTTP — pulls down web pages from a single location at a time and has no built-in mechanism for archiving the online pages. IPFS allows users to download a page simultaneously from multiple locations and includes what programmers call “historic versioning,” so that past iterations do not vanish from the historical record. To support the protocol, Benet is also creating a system called Filecoin that will allow users to effectively rent out unused hard-drive space. (Think of it as a sort of Airbnb for data.) “Right now there are tons of hard drives around the planet that are doing nothing, or close to nothing, to the point where their owners are just losing money,” Benet said. “So you can bring online a massive amount of supply, which will bring down the costs of storage.” But as its name suggests, Protocol Labs has an ambition that extends beyond these projects; Benet’s larger mission is to support many new open-source protocols in the years to come.

Why did the internet follow the path from open to closed? One part of the explanation lies in sins of omission: By the time a new generation of coders began to tackle the problems that InternetOne left unsolved, there were near-limitless sources of capital to invest in those efforts, so long as the coders kept their systems closed. The secret to the success of the open protocols of InternetOne is that they were developed in an age when most people didn’t care about online networks, so they were able to stealthily reach critical mass without having to contend with wealthy conglomerates and venture capitalists. By the mid-2000s, though, a promising new start-up like Facebook could attract millions of dollars in financing even before it became a household brand. And that private-sector money ensured that the company’s key software would remain closed, in order to capture as much value as possible for shareholders.

And yet — as the venture capitalist Chris Dixon points out — there was another factor, too, one that was more technical than financial in nature. “Let’s say you’re trying to build an open Twitter,” Dixon explained while sitting in a conference room at the New York offices of Andreessen Horowitz, where he is a general partner. “I’m @cdixon at Twitter. Where do you store that? You need a database.” A closed architecture like Facebook’s or Twitter’s puts all the information about its users — their handles, their likes and photos, the map of connections they have to other individuals on the network — into a private database that is maintained by the company. Whenever you look at your Facebook newsfeed, you are granted access to some infinitesimally small section of that database, seeing only the information that is relevant to you.

Running Facebook’s database is an unimaginably complex operation, relying on hundreds of thousands of servers scattered around the world, overseen by some of the most brilliant engineers on the planet. From Facebook’s point of view, they’re providing a valuable service to humanity: creating a common social graph for almost everyone on earth. The fact that they have to sell ads to pay the bills for that service — and the fact that the scale of their network gives them staggering power over the minds of two billion people around the world — is an unfortunate, but inevitable, price to pay for a shared social graph. And that trade-off did in fact make sense in the mid-2000s; creating a single database capable of tracking the interactions of hundreds of millions of people — much less two billion — was the kind of problem that could be tackled only by a single organization. But as Benet and his fellow blockchain evangelists are eager to prove, that might not be true anymore.

So how can you get meaningful adoption of base-layer protocols in an age when the big tech companies have already attracted billions of users and collectively sit on hundreds of billions of dollars in cash? If you happen to believe that the internet, in its current incarnation, is causing significant and growing harm to society, then this seemingly esoteric problem — the difficulty of getting people to adopt new open-source technology standards — turns out to have momentous consequences. If we can’t figure out a way to introduce new, rival base-layer infrastructure, then we’re stuck with the internet we have today. The best we can hope for is government interventions to scale back the power of Facebook or Google, or some kind of consumer revolt that encourages that marketplace to shift to less hegemonic online services, the digital equivalent of forswearing big agriculture for local farmers’ markets. Neither approach would upend the underlying dynamics of Internet Two.

 

 

The first hint of a meaningful challenge to the closed-protocol era arrived in 2008, not long after Zuckerberg opened the first international headquarters for his growing company. A mysterious programmer (or group of programmers) going by the name Satoshi Nakamoto circulated a paper on a cryptography mailing list. The paper was called “Bitcoin: A Peer-to-Peer Electronic Cash System,” and in it, Nakamoto outlined an ingenious system for a digital currency that did not require a centralized trusted authority to verify transactions. At the time, Facebook and Bitcoin seemed to belong to entirely different spheres — one was a booming venture-backed social-media start-up that let you share birthday greetings and connect with old friends, while the other was a byzantine scheme for cryptographic currency from an obscure email list. But 10 years later, the ideas that Nakamoto unleashed with that paper now pose the most significant challenge to the hegemony of InternetTwo giants like Facebook.

The paradox about Bitcoin is that it may well turn out to be a genuinely revolutionary breakthrough and at the same time a colossal failure as a currency. As I write, Bitcoin has increased in value by nearly 100,000 percent over the past five years, making a fortune for its early investors but also branding it as a spectacularly unstable payment mechanism. The process for creating new Bitcoins has also turned out to be a staggering energy drain.

History is replete with stories of new technologies whose initial applications end up having little to do with their eventual use. All the focus on Bitcoin as a payment system may similarly prove to be a distraction, a technological red herring. Nakamoto pitched Bitcoin as a “peer-to-peer electronic-cash system” in the initial manifesto, but at its heart, the innovation he (or she or they) was proposing had a more general structure, with two key features.

First, Bitcoin offered a kind of proof that you could create a secure database — the blockchain — scattered across hundreds or thousands of computers, with no single authority controlling and verifying the authenticity of the data.

Second, Nakamoto designed Bitcoin so that the work of maintaining that distributed ledger was itself rewarded with small, increasingly scarce Bitcoin payments. If you dedicated half your computer’s processing cycles to helping the Bitcoin network get its math right — and thus fend off the hackers and scam artists — you received a small sliver of the currency. Nakamoto designed the system so that Bitcoins would grow increasingly difficult to earn over time, ensuring a certain amount of scarcity in the system. If you helped Bitcoin keep that database secure in the early days, you would earn more Bitcoin than later arrivals. This process has come to be called “mining.”

For our purposes, forget everything else about the Bitcoin frenzy, and just keep these two things in mind: What Nakamoto ushered into the world was a way of agreeing on the contents of a database without anyone being “in charge” of the database, and a way of compensating people for helping make that database more valuable, without those people being on an official payroll or owning shares in a corporate entity. Together, those two ideas solved the distributed-database problem and the funding problem. Suddenly there was a way of supporting open protocols that wasn’t available during the infancy of Facebook and Twitter.

These two features have now been replicated in dozens of new systems inspired by Bitcoin. One of those systems is Ethereum, proposed in a white paper by Vitalik Buterin when he was just 19. Ethereum does have its currencies, but at its heart Ethereum was designed less to facilitate electronic payments than to allow people to run applications on top of the Ethereum blockchain. There are currently hundreds of Ethereum apps in development, ranging from prediction markets to Facebook clones to crowdfunding services. Almost all of them are in pre-alpha stage, not ready for consumer adoption. Despite the embryonic state of the applications, the Ether currency has seen its own miniature version of the Bitcoin bubble, most likely making Buterin an immense fortune.

These currencies can be used in clever ways. Juan Benet’s Filecoin system will rely on Ethereum technology and reward users and developers who adopt its IPFS protocol or help maintain the shared database it requires. Protocol Labs is creating its own cryptocurrency, also called Filecoin, and has plans to sell some of those coins on the open market in the coming months. (In the summer of 2017, the company raised $135 million in the first 60 minutes of what Benet calls a “presale” of the tokens to accredited investors.) Many cryptocurrencies are first made available to the public through a process known as an initial coin offering, or I.C.O.

The I.C.O. abbreviation is a deliberate echo of the initial public offering that so defined the first internet bubble in the 1990s. But there is a crucial difference between the two. Speculators can buy in during an I.C.O., but they are not buying an ownership stake in a private company and its proprietary software, the way they might in a traditional I.P.O. Afterward, the coins will continue to be created in exchange for labor — in the case of Filecoin, by anyone who helps maintain the Filecoin network. Developers who help refine the software can earn the coins, as can ordinary users who lend out spare hard-drive space to expand the network’s storage capacity. The Filecoin is a way of signaling that someone, somewhere, has added value to the network.

. You need new code.

 

 

Part II What is Fractional Banking System?

 

Money Creation in a Fractional Reserve Banking System

In a fractional reserve banking system, banks create money when they make loans. 

Bank reserves have a multiplier effect on the money supply.

 

Example: You deposited $1,000 in a local bank

 

image006.jpg

 

Iteration #

Deposited

=

Reserves

+

Available to Lend

Bank

Lends to

1. A

1,000.00

=

100

+

900

A

2. B

900

=

90

+

810

3. C

810

=

81

+

729

C

4. D

729

=

72.9

+

656.1

D

And the cycle continues…

 

Summary: Template here FYI (updated)

 

Iteration #

Deposited by

Amount Held

Amount

Total Amount that

Total Amount that

Total Amount

Total Amount that

Customer

in Reserve

Currently

“Can” be

Has Been

Held in Reserve

Customers Believe

 

from Deposit

Available to

Lent Out

Lent Out

 

They Have

 

 

Lend Out

 

 

 

 

 

 

from Deposit

 

 

 

 

1

1,000.00

100

900

900

0

100

1,000.00

2

900

90

810

1,710.00

900

190

1,900.00

3

810

81

729

2,439.00

1,710.00

271

2,710.00

4

729

72.9

656.1

3,095.10

2,439.00

343.9

3,439.00

5

656.1

65.61

590.49

3,685.59

3,095.10

409.51

4,095.10

6

590.49

59.05

531.44

4,217.03

3,685.59

468.56

4,685.59

7

531.44

53.14

478.3

4,695.33

4,217.03

521.7

5,217.03

8

478.3

47.83

430.47

5,125.80

4,695.33

569.53

5,695.33

9

430.47

43.05

387.42

5,513.22

5,125.80

612.58

6,125.80

10

387.42

38.74

348.68

5,861.89

5,513.22

651.32

6,513.22

 

 

(continuing from above)

Advocates like Chris Dixon have started referring to the compensation side of the equation in terms of “tokens,” not coins, to emphasize that the technology here isn’t necessarily aiming to disrupt existing currency systems. “I like the metaphor of a token because it makes it very clear that it’s like an arcade,” he says. “You go to the arcade, and in the arcade you can use these tokens. But we’re not trying to replace the U.S. government. It’s not meant to be a real currency; it’s meant to be a pseudo-currency inside this world.” Dan Finlay, a creator of MetaMask, echoes Dixon’s argument. “To me, what’s interesting about this is that we get to program new value systems,” he says. “They don’t have to resemble money.”

Pseudo or not, the idea of an I.C.O. has already inspired a host of shady offerings, some of them endorsed by celebrities who would seem to be unlikely blockchain enthusiasts, like DJ Khaled, Paris Hilton and Floyd Mayweather. In a blog post published in October 2017, Fred Wilson, a founder of Union Square Ventures and an early advocate of the blockchain revolution, thundered against the spread of I.C.O.s. “I hate it,” Wilson wrote, adding that most I.C.O.s “are scams. And the celebrities and others who promote them on their social-media channels in an effort to enrich themselves are behaving badly and possibly violating securities laws.” Arguably the most striking thing about the surge of interest in I.C.O.s — and in existing currencies like Bitcoin or Ether — is how much financial speculation has already gravitated to platforms that have effectively zero adoption among ordinary consumers. At least during the internet bubble of late 1990s, ordinary people were buying books on Amazon or reading newspapers online; there was clear evidence that the web was going to become a mainstream platform. Today, the hype cycles are so accelerated that billions of dollars are chasing a technology that almost no one outside the cryptocommunity understands, much less uses.

Let’s say, for the sake of argument, that the hype is warranted, and blockchain platforms like Ethereum become a fundamental part of our digital infrastructure. How would a distributed ledger and a token economy somehow challenge one of the tech giants? One of Fred Wilson’s partners at Union Square Ventures, Brad Burnham, suggests a scenario revolving around another tech giant that has run afoul of regulators and public opinion in the last year: Uber. “Uber is basically just a coordination platform between drivers and passengers,” Burnham says. “Yes, it was really innovative, and there were a bunch of things in the beginning about reducing the anxiety of whether the driver was coming or not, and the map — and a whole bunch of things that you should give them a lot of credit for.” But when a new service like Uber starts to take off, there’s a strong incentive for the marketplace to consolidate around a single leader. The fact that more passengers are starting to use the Uber app attracts more drivers to the service, which in turn attracts more passengers. People have their credit cards stored with Uber; they have the app installed already; there are far more Uber drivers on the road. And so the switching costs of trying out some other rival service eventually become prohibitive, even if the chief executive seems to be a jerk or if consumers would, in the abstract, prefer a competitive marketplace with a dozen Ubers. “At some point, the innovation around the coordination becomes less and less innovative,” Burnham says.

The blockchain world proposes something different. Imagine some group like Protocol Labs decides there’s a case to be made for adding another “basic layer” to the stack. Just as GPS gave us a way of discovering and sharing our location, this new protocol would define a simple request: I am here and would like to go there. A distributed ledger might record all its users’ past trips, credit cards, favorite locations — all the metadata that services like Uber or Amazon use to encourage lock-in. Call it, for the sake of argument, the Transit protocol. The standards for sending a Transit request out onto the internet would be entirely open; anyone who wanted to build an app to respond to that request would be free to do so. Cities could build Transit apps that allowed taxi drivers to field requests. But so could bike-share collectives, or rickshaw drivers. Developers could create shared marketplace apps where all the potential vehicles using Transit could vie for your business. When you walked out on the sidewalk and tried to get a ride, you wouldn’t have to place your allegiance with a single provider before hailing. You would simply announce that you were standing at 67th and Madison and needed to get to Union Square. And then you’d get a flurry of competing offers. You could even theoretically get an offer from the M.T.A., which could build a service to remind Transit users that it might be much cheaper and faster just to jump on the 6 train.

How would Transit reach critical mass when Uber and Lyft already dominate the ride-sharing market? This is where the tokens come in. Early adopters of Transit would be rewarded with Transit tokens, which could themselves be used to purchase Transit services or be traded on exchanges for traditional currency. As in the Bitcoin model, tokens would be doled out less generously as Transit grew more popular. In the early days, a developer who built an iPhone app that uses Transit might see a windfall of tokens; Uber drivers who started using Transit as a second option for finding passengers could collect tokens as a reward for embracing the system; adventurous consumers would be rewarded with tokens for using Transit in its early days, when there are fewer drivers available compared with the existing proprietary networks like Uber or Lyft.

As Transit began to take off, it would attract speculators, who would put a monetary price on the token and drive even more interest in the protocol by inflating its value, which in turn would attract more developers, drivers and customers. If the whole system ends up working as its advocates believe, the result is a more competitive but at the same time more equitable marketplace. Instead of all the economic value being captured by the shareholders of one or two large corporations that dominate the market, the economic value is distributed across a much wider group: the early developers of Transit, the app creators who make the protocol work in a consumer-friendly form, the early-adopter drivers and passengers, the first wave of speculators. Token economies introduce a strange new set of elements that do not fit the traditional models: instead of creating value by owning something, as in the shareholder equity model, people create value by improving the underlying protocol, either by helping to maintain the ledger (as in Bitcoin mining), or by writing apps atop it, or simply by using the service. The lines between founders, investors and customers are far blurrier than in traditional corporate models; all the incentives are explicitly designed to steer away from winner-take-all outcomes. And yet at the same time, the whole system depends on an initial speculative phase in which outsiders are betting on the token to rise in value.

“You think about the ’90s internet bubble and all the great infrastructure we got out of that,” Dixon says. “You’re basically taking that effect and shrinking it down to the size of an application.”

Bitcoin is now a nine-year-old multibillion-dollar bug bounty, and no one’s hacked it. It feels like pretty good proof.’

Even decentralized cryptomovements have their key nodes. For Ethereum, one of those nodes is the Brooklyn headquarters of an organization called ConsenSys, founded by Joseph Lubin, an early Ethereum pioneer. In November, Amanda Gutterman, the 26-year-old chief marketing officer for ConsenSys, gave me a tour of the space. In our first few minutes together, she offered the obligatory cup of coffee, only to discover that the drip-coffee machine in the kitchen was bone dry. “How can we fix the internet if we can’t even make coffee?” she said with a laugh.

 

Part III: Crypto currency

 

ppt (Thanks, Chris)

 

ppt 2  

 

 

 

image011.jpg

 

 

image012.jpg

 

 

https://www.coinbase.com/price

Top 50 crypocurrency

 

image013.jpg

 

 

 

 

 

 

What is Bitcoin? (video)

What is bitcoin? By Khan Academy (video) (optional)

 

 

Two Biggest Threats To The Ongoing Bitcoin And Ethereum Rallies

https://www.forbes.com/sites/youngjoseph/2020/09/01/bitcoin-dollar-ethereum/#358120e95939

Joseph Young Contributor

 

The price of Bitcoin rose to as high as $12,086 on Coinbase, as Ethereum (ETH) buoyed overall market sentiment. While the cryptocurrency market’s momentum is evidently strong, there are two potential threats to the rally.

 

The two possible obstacles to the ongoing Bitcoin and Ethereum rallies are the U.S. dollar recovery and the historical performance of BTC in the month of September.

 

Is The Weakening U.S. Dollar Momentum Reversing?

Analysts have generally attributed the upsurge of both Bitcoin and gold to the fading dollar in recent months. 

In late July, the U.S. dollar plunged to a two-year low due to the slowing economy and soaring virus cases.

Since then, the U.S. dollar has continuously declined. From March, within five months, the U.S. dollar index dropped from 102.99 points to 91.75 points, by more than 10%.

The weakening dollar seemingly fueled the sentiment around alternative assets, including Bitcoin and gold.

But, some analysts say that the decline of the dollar is overexaggerated. On August 23, Capital Economics’ senior economist Jonas Goltermann said the DXY does not depict the full picture.

He described the “downfall” of the dollar as a “greatly exaggerated” narrative. He noted that the U.S. dollar remains the dominant reserve currency, with more stability over the euro and renminbi.

“Perhaps more importantly, there is no obvious alternative to the dollar. The next two largest economies, the euro-zone and China, are both smaller than the US, and the euro (due to its still-fragile political underpinnings) and the renminbi (due to China’s capital controls and unique political system) have significant shortcomings as reserve currencies,” he said.

The U.S. dollar has fallen sharply since May, and it remains to be seen whether the dollar could rebound at a key support area.

 

The recovery of the dollar could cause the uptrend of Bitcoin, gold, and other cryptocurrencies to slow.

 

Another potential factor to consider is the historical performance of Bitcoin during the month of September.

Every monthly candle in the last three years for the month of September closed as red. While the data is more coincidental than cyclical, it would be compelling to see if the pattern breaks for the first time in 4 years.

The Momentum of Bitcoin And Ethereum Remains Strong

For now, the momentum of both Bitcoin and Ethereum remains strong. Even at a high price point, the on-chain market analysis firm Santiment said traders are undecided on whether to take profit.

“BTC jumped above $12k today for the first time in 2 weeks, while $ETH hit a 25-month high of $485. Volume, especially for #Ethereum, has soared as traders polarize and decide whether to #FOMO in or profit take,” Santiment researchers said.

Key on-chain data points also continuously signal the start to an extended rally. Rafael Schultz-Kraft, the chief technical officer at Glassnode, said the Bitcoin short-term holder net unrealized profit and loss activity (NUPL) has been above zero for four months.

A positive NUPL historically “served as an indication for BTC bull markets,” Kraft noted.

 

 

Homework of chapter 2 (due with first mid term)

1.      Write down the definition of M0, M1, M2 and M3; Which one is used as a measure of money supply in this country? How much is it by the end of July 2020?

2.      From Fed St. Louis website, find the most recent charts of M1 money stock and M2 money stock.

http://research.stlouisfed.org/fred2/categories/24

Compare the two charts and discuss the differences between the two charts. 

3.What is fractional banking system?

 Imagine that you deposited $5,000 in Bank A. Reserve ratio is 0.1.  Imagine that the fractional banking system is fully functioning. After five cycles, what is the amount that has been deposited and what is the total amount that has been lent out? Template here FYI

4.  What is bitcoin? In your view, could bitcoin become a major global currency? Could governments ban or destroy bitcoin?

5. What about other crypto? Some are really cheap. /Do you plan to invest in them? Why or why not?

      6. What are the Two Biggest Threats To The Ongoing Bitcoin And Ethereum Rallies according to https://www.forbes.com/sites/youngjoseph/2020/09/01/bitcoin-dollar-ethereum/#358120e95939

 

 

 

(continuing from above)

Planted in industrial Bushwick, a stone’s throw from the pizza mecca Roberta’s, “headquarters” seemed an unlikely word. The front door was festooned with graffiti and stickers; inside, the stairwells of the space appeared to have been last renovated during the Coolidge administration. Just about three years old, the ConsenSys network now includes more than 550 employees in 28 countries, and the operation has never raised a d0ime of venture capital. As an organization, ConsenSys does not quite fit any of the usual categories: It is technically a corporation, but it has elements that also resemble nonprofits and workers’ collectives. The shared goal of ConsenSys members is strengthening and expanding the Ethereum blockchain. They support developers creating new apps and tools for the platform, one of which is MetaMask, the software that generated my Ethereum address. But they also offer consulting-style services for companies, nonprofits or governments looking for ways to integrate Ethereum’s smart contracts into their own systems.

The true test of the blockchain will revolve — like so many of the online crises of the past few years — around the problem of identity. Today your digital identity is scattered across dozens, or even hundreds, of different sites: Amazon has your credit-card information and your purchase history; Facebook knows your friends and family; Equifax maintains your credit history. When you use any of those services, you are effectively asking for permission to borrow some of that information about yourself in order perform a task: ordering a Christmas present for your uncle, checking Instagram to see pictures from the office party last night. But all these different fragments of your identity don’t belong to you; they belong to Facebook and Amazon and Google, who are free to sell bits of that information about you to advertisers without consulting you. You, of course, are free to delete those accounts if you choose, and if you stop checking Facebook, Zuckerberg and the Facebook shareholders will stop making money by renting out your attention to their true customers. But your Facebook or Google identity isn’t portable. If you want to join another promising social network that is maybe a little less infected with Russian bots, you can’t extract your social network from Twitter and deposit it in the new service. You have to build the network again from scratch (and persuade all your friends to do the same).

The blockchain evangelists think this entire approach is backward. You should own your digital identity — which could include everything from your date of birth to your friend networks to your purchasing history — and you should be free to lend parts of that identity out to services as you see fit. Given that identity was not baked into the original internet protocols, and given the difficulty of managing a distributed database in the days before Bitcoin, this form of “self-sovereign” identity — as the parlance has it — was a practical impossibility. Now it is an attainable goal. A number of blockchain-based services are trying to tackle this problem, including a new identity system called uPort that has been spun out of ConsenSys and another one called Blockstack that is currently based on the Bitcoin platform. (Tim Berners-Lee is leading the development of a comparable system, called Solid, that would also give users control over their own data.) These rival protocols all have slightly different frameworks, but they all share a general vision of how identity should work on a truly decentralized internet.

What would prevent a new blockchain-based identity standard from following Tim Wu’s Cycle, the same one that brought Facebook to such a dominant position? Perhaps nothing. But imagine how that sequence would play out in practice. Someone creates a new protocol to define your social network via Ethereum. It might be as simple as a list of other Ethereum addresses; in other words, Here are the public addresses of people I like and trust. That way of defining your social network might well take off and ultimately supplant the closed systems that define your network on Facebook. Perhaps someday, every single person on the planet might use that standard to map their social connections, just as every single person on the internet uses TCP/IP to share data. But even if this new form of identity became ubiquitous, it wouldn’t present the same opportunities for abuse and manipulation that you find in the closed systems that have become de facto standards. I might allow a Facebook-style service to use my social map to filter news or gossip or music for me, based on the activity of my friends, but if that service annoyed me, I’d be free to sample other alternatives without the switching costs. An open identity standard would give ordinary people the opportunity to sell their attention to the highest bidder, or choose to keep it out of the marketplace altogether.

Gutterman suggests that the same kind of system could be applied to even more critical forms of identity, like health care data. Instead of storing, say, your genome on servers belonging to a private corporation, the information would instead be stored inside a personal data archive. “There may be many corporate entities that I don’t want seeing that data, but maybe I’d like to donate that data to a medical study,” she says. “I could use my blockchain-based self-sovereign ID to [allow] one group to use it and not another. Or I could sell it over here and give it away over there.”

The token architecture would give a blockchain-based identity standard an additional edge over closed standards like Facebook’s. As many critics have observed, ordinary users on social-media platforms create almost all the content without compensation, while the companies capture all the economic value from that content through advertising sales. A token-based social network would at least give early adopters a piece of the action, rewarding them for their labors in making the new platform appealing. “If someone can really figure out a version of Facebook that lets users own a piece of the network and get paid,” Dixon says, “that could be pretty compelling.”

Would that information be more secure in a distributed blockchain than behind the elaborate firewalls of giant corporations like Google or Facebook? In this one respect, the Bitcoin story is actually instructive: It may never be stable enough to function as a currency, but it does offer convincing proof of just how secure a distributed ledger can be. “Look at the market cap of Bitcoin or Ethereum: $80 billion, $25 billion, whatever,” Dixon says. “That means if you successfully attack that system, you could walk away with more than a billion dollars. You know what a ‘bug bounty’ is? Someone says, ‘If you hack my system, I’ll give you a million dollars.’ So Bitcoin is now a nine-year-old multibillion-dollar bug bounty, and no one’s hacked it. It feels like pretty good proof.”

Additional security would come from the decentralized nature of these new identity protocols. In the identity system proposed by Blockstack, the actual information about your identity — your social connections, your purchasing history — could be stored anywhere online. The blockchain would simply provide cryptographically secure keys to unlock that information and share it with other trusted providers. A system with a centralized repository with data for hundreds of millions of users — what security experts call “honey pots” — is far more appealing to hackers. Which would you rather do: steal a hundred million credit histories by hacking into a hundred million separate personal computers and sniffing around until you found the right data on each machine? Or just hack into one honey pot at Equifax and walk away with the same amount of data in a matter of hours? As Gutterman puts it, “It’s the difference between robbing a house versus robbing the entire village.”

So much of the blockchain’s architecture is shaped by predictions about how that architecture might be abused once it finds a wider audience. That is part of its charm and its power. The blockchain channels the energy of speculative bubbles by allowing tokens to be shared widely among true supporters of the platform. It safeguards against any individual or small group gaining control of the entire database. Its cryptography is designed to protect against surveillance states or identity thieves. In this, the blockchain displays a familial resemblance to political constitutions: Its rules are designed with one eye on how those rules might be exploited down the line.

Much has been made of the anarcho-libertarian streak in Bitcoin and other nonfiat currencies; the community is rife with words and phrases (“self-sovereign”) that sound as if they could be slogans for some militia compound in Montana. And yet in its potential to break up large concentrations of power and explore less-proprietary models of ownership, the blockchain idea offers a tantalizing possibility for those who would like to distribute wealth more equitably and break up the cartels of the digital age.

The blockchain worldview can also sound libertarian in the sense that it proposes nonstate solutions to capitalist excesses like information monopolies. But to believe in the blockchain is not necessarily to oppose regulation, if that regulation is designed with complementary aims. Brad Burnham, for instance, suggests that regulators should insist that everyone have “a right to a private data store,” where all the various facets of their online identity would be maintained. But governments wouldn’t be required to design those identity protocols. They would be developed on the blockchain, open source. Ideologically speaking, that private data store would be a true team effort: built as an intellectual commons, funded by token speculators, supported by the regulatory state.

Like the original internet itself, the blockchain is an idea with radical — almost communitarian — possibilities that at the same time has attracted some of the most frivolous and regressive appetites of capitalism. We spent our first years online in a world defined by open protocols and intellectual commons; we spent the second phase in a world increasingly dominated by closed architectures and proprietary databases. We have learned enough from this history to support the hypothesis that open works better than closed, at least where base-layer issues are concerned. But we don’t have an easy route back to the open-protocol era. Some messianic next-generation internet protocol is not likely to emerge out of Department of Defense research, the way the first-generation internet did nearly 50 years ago.

Yes, the blockchain may seem like the very worst of speculative capitalism right now, and yes, it is demonically challenging to understand. But the beautiful thing about open protocols is that they can be steered in surprising new directions by the people who discover and champion them in their infancy. Right now, the only real hope for a revival of the open-protocol ethos lies in the blockchain. Whether it eventually lives up to its egalitarian promise will in large part depend on the people who embrace the platform, who take up the baton, as Juan Benet puts it, from those early online pioneers. If you think the internet is not working in its current incarnation, you can’t change the system through think-pieces and F.C.C. regulations alone

Chapter 3 Financial Instruments, Financial Markets, and Financial Institutions

 

Ppt

 

Part I: Examples and characteristics of financial instruments 

 

Discussion: You have some extra bucks. What will you do with the money?

 

With extra bucks è Find a proper financial instruments è find a financial institution è trade in the market

 

How does the Money Market work? (video)

 

  

Part II: Order types (supplement materials)

Order types (market, limit, stop), video

Understanding order types by wall street survivor

 

 

For discussion:

1.      Why did the other seller reduce the asking price after she posted her selling order?

2.      Why did she hide her purchasing orders of 20,000 shares?

 

Understanding Stock Orders that you can try

1.       Market order:  A market order instructs your broker to buy or sell the stock immediately at the prevailing price, whatever that may be.

 

2.       Limit order:  Limit orders instruct your broker to buy or sell a stock at a particular price. The purchase or sale will not happen unless you get your price.

image014.jpg(www.investorpedia.com)

For example, our example portfolio purchased shares of Wal-Mart for $70.35 per share. Now we plan to sell our WMT shares after they realize a $10, or roughly 20%, increase. However, rather than constantly checking the market several times in a single day, with the intent of entering a market sell order once WMT reaches at least $80.35 per share, we can submit a simple limit sell order to do that for us.

 
Click on Sell for the Transaction type and enter 100 for the Quantity. For the order price, you need to select the button corresponding to Limit and then enter 80.35 as the limit price - this will ensure your order to sell WMT shares will not occur unless you can get at least $80.35 per share for your position of WMT shares. We keep the order's Term set at "Good Till Cancelled", which means the order will stay active and be processed once WMT shares reach or exceed your limit price. (*Note: We could have set Term to be "Day Order", which means the order would expire at the end of the current trading day if the order does not execute).

As you can see, the use of limit sell orders is very useful if you wish to sell a stock at a specific target price, but are unwilling or unable to regularly check intraday or daily closing prices of the stock. Also, an added advantage of using limit sell orders is that they remove the emotional component of making trading decisions. Too often, investors will be tempted to hold on to a winning stock even once it becomes overpriced. Submitting a limit sell order immediately after you buy the stock is a good time to avoid any emotional complications, allowing you to better maintain your strategy and realize superior long-term returns.

Similarly, limit buy orders are equally useful. You can enter a limit buy order with a certain limit price, which allows you to buy a set number of shares only if the stock's market price equal to, or lower than, the maximum limit price you entered. In our example portfolio we purchased WMT for $70.35/share with a market buy order. But perhaps we thought WMT was a bit overpriced at the time, so we could have used a limit buy order to purchase 100 shares only if WMT fell to $65.00/share or less. That way, we only buy at a price we believe is fair. If WMT does not fall to $65, the order will not be processed.

 

 

3.       Stop loss order:  A stop loss order gives your broker a price trigger that protects you from a big drop in a stock.

image015.jpg (www.investorpedia.com)

Essentially, a stop order is "dormant" until a stock's price falls to the specified "stop price". In other words, a stop order is an instruction to your brokerage to buy (or sell) a specified number of shares of a company when the prevailing market price is equal or higher than (or, in the case of a sell stop order, equal or lower than) the specified price that you submitted. In our example portfolio, we purchased shares of Google Inc (Nasdaq: GOOG) for $463.18 per share. Many investors use a sell stop order to limit their losses, meaning that they'll automatically sell if a stock goes down a certain percentage.

Entering a stop order is an efficient and cost-effective means of limiting losses by avoiding the agony of regularly checking your stock and deciding whether to hold or sell it. For instance, if a so-called growth stock has headed south, an investor may choose to hold, hoping the share price might rebound, but if it doesn't, losses can quickly mount.

 

2.      Short selling: 

video

For class discussion: Pro and cons of short selling?

image016.jpg(www.investorpedia.com)

As you can see, short selling follows the conventional investing principle of “buying low” and “selling high” but with one critical difference – the sequence of the buy and sell transactions. While the buy transaction precedes the sell transaction in conventional “long only” investing, in short selling, the sell transaction precedes the buy transaction.

When you short sell, you create a short position or a shortfall. A short position represents a binding obligation that must be closed or covered at some point. This “short covering” obligation gives rise to one of the biggest risks of short selling, as discussed later in this tutorial. 

Short selling is also known as "shorting," "selling short" or "going short." To be short a security or asset implies that one is bearish on it and expects the price to decline. Short selling has also spawned some of the most colorful terms in the investment lexicon.

Short selling can be used for speculation or hedging. Speculators use short selling to capitalize on a potential decline in a specific security or the broad market. Hedgers use the strategy to protect gains or mitigate losses in a security or portfolio. Note that institutional investors and savvy individuals frequently engage in short selling strategies simultaneously for both speculation and hedging. Hedge funds are among the most active short sellers, and often use short positions in select stocks or sectors to hedge their long positions in other stocks.

Short sellers are often portrayed as cynical, hardened individuals who are bent on making profits by driving the companies that are their “short” targets to failure and bankruptcy. The reality, however, is that short sellers facilitate smooth functioning of the markets by providing liquidity, and also act as a restraining influence on investors who may be prone to chase overhyped stocks, especially during periods of irrational exuberance. 

Short selling is viewed by many investors as an inordinately dangerous strategy, since the long-term trend of the equity market is generally upward and there is theoretically no upper limit to how high a stock can rise. But under the right circumstances, short selling can be a viable and profitable investment strategy for experienced traders and investors who have an adequate degree of risk tolerance and are familiar with the risks involved in shorting. 

 

Example:

Let's say XYZ's current ask price is 53. You place an order to buy at a limit price of 50. If the price of the security falls to 50, your order may be executed. If you had placed a limit order to buy at 53 or above, your order would have been "marketable" and executed right away.

 

In Class Exercise part I   

 

Multiple Choices

1.   A trading order that immediately purchases stock at the prevailing price is called a:

a.   stop-loss order

b.   limit order.

         c.   market order.

 (DEFINITION of 'Stop-Loss Order': An order placed with a broker to sell a security when it reaches a certain price. A stop-loss order is designed to limit an investor’s loss on a position in a security. Although most investors associate a stop-loss order only with a long position, it can also be used for a short position, in which case the security would be bought if it trades above a defined price. A stop-loss order takes the emotion out of trading decisions and can be especially handy when one is on vacation or cannot watch his/her position. Also known as a “stop order” or “stop-market order.”) video: http://www.investopedia.com/terms/s/stop-lossorder.asp )


2.   A trading order that immediately purchases stock or is completely cancelled is called a:

a.  stop-loss order.

           b.  fill-or-kill limit order.

c.  market order.

d.  open order.

(DEFINITION of 'Fill Or Kill - FOK': A type of time-in-force designation used in securities trading that instructs a brokerage to execute a transaction immediately and completely or not at all. This type of order is most likely to be used by active traders and is usually for a large quantity of stock. The order must be filled in its entirety or canceled (killed). The purpose of a fill or kill order is to ensure that a position is entered at a desired price.)

(Definition of ‘Open Order’: A type of order to buy or sell a security that remains in effect until it is either canceled by the customer, until it is executed or until it expires. Open orders commonly occur when investors place restrictions on their buy and sell transactions. A lack of liquidity in the market or for a particular security can also cause an order to remain open. )

 
3.     A  trading order that is canceled unless executed within a designated time period is called a

a.    stop-loss order.

b.    limit order.

c.    market order.

           d.    fill or kill order.

 

4.     Limit orders:

a.    specify a certain price at which a market order takes effect.

           b.    specify a particular price to be met or bettered.

c.    are executed at the best price available.

d.    are orders entered for a particular day.

 

5.     A market order is an instruction to:

        a)    immediately buy a security at the current bid price. ----- (wrong, because buy at the ask price, and sell at the bid price)

b)    buy if the market price at least reaches the specified price target.

c)    sell at or above a specified price target.

        d)    none of these.

 

 

 

Part III: IPO, SEO, Primary Market and Secondary Market

What is an IPO | by Wall Street Survivor (video)

What is an IPO? | CNBC Explains (video)

A lesson from Facebook -- avoid IPOs - MoneyWeek Investment Tutorials

 

For class discussion:

1. What is IPO? SEO? Who are the major participants?

2. Why do firms hire investment banks for IPO and SEO? Can they do the IPO and SEO by themselves?

2. What is the primary market? What is the secondary market? Who are the major participants in these markets?

3. Shall a company go public? What is your opinion?

 

IPO Calendar

This Week (http://www.marketwatch.com/tools/ipo-calendar)

 

 THIS WEEK • 2 TOTAL

COMPANY NAME

PROPOSED SYMBOL

EXCHANGE

PRICE RANGE

SHARES

WEEK OF

Lightspeed POS

LSPD

NYSE

$32.31

11,650,000

9/7/2020

Prime Impact Acquisition I

PIAI.U

NYSE

$10.00

30,000,000

9/7/2020

NEXT WEEK • 11 TOTAL

COMPANY NAME

PROPOSED SYMBOL

EXCHANGE

PRICE RANGE

SHARES

WEEK OF

American Well

AMWL

NYSE

$14.00 - $16.00

35,000,000

9/14/2020

Broadstone Net Lease

BNL

NYSE

$17.00 - $19.00

33,500,000

9/14/2020

JFrog

FROG

Nasdaq

$33.00 - $37.00

11,568,218

9/14/2020

Metacrine

MTCR

Nasdaq

$12.00 - $14.00

6,540,000

9/14/2020

Outset Medical

OM

Nasdaq

$22.00 - $24.00

7,600,000

9/14/2020

Pactiv Evergreen

PTVE

Nasdaq

$18.00 - $21.00

41,026,000

9/14/2020

Snowflake

SNOW

NYSE

$75.00 - $85.00

28,000,000

9/14/2020

StepStone Group

STEP

Nasdaq

$15.00 - $17.00

17,500,000

9/14/2020

Sumo Logic

SUMO

Nasdaq

$17.00 - $21.00

14,800,000

9/14/2020

Unity Software

U

NYSE

$34.00 - $42.00

25,000,000

9/14/2020

Vitru

VTRU

Nasdaq

$22.00 - $24.00

11,230,126

9/14/2020

 

 

In Class Exercise part II   

 

Multiple Choices

1.     The market for equities is predominantly a:

a.    primary market.

b.    market dominated by individual investors.

        c.    secondary market.

d.    market dominated by foreign investors.

 

2.     Primary markets:

a.    involve the organized trading of outstanding securities on exchanges.

b.    involve the organized trading of outstanding securities in the over-the-counter market.

c.    involve the organized trading of outstanding securities on exchanges and over-the-counter markets.

        d.    are where new issues (IPOs) are sold by corporations to raise new capital.

 

 

SEC develops fund-like plan to give retail investors access to pre-IPO shares

 

By Charles GasparinoLydia MoynihanPublished September 18, 2019

SEC in early stages of discussions to allow pre-IPO purchasing (video)

 

The Securities and Exchange Commission is looking to clear a path for small investors to access the burgeoning market for private company stocks. The effort could involve new rulemaking that would allow for the creation of a hedge fund-like instrument that invests in pre-IPO shares structured for the average retail investor, the Fox Business Network has learned.

The SEC initiative is still in the discussion stages and its timing of any implementation is unclear. But the talks follow recent remarks made by SEC Chairman Jay Clayton, who said small investors should have access to buying pre-IPO shares – a market that is open only to large institutional investors and accredited individual investors who either have a net worth of $1 million or make $200,000 annually.

The market for buying and selling pre-IPO shares is indeed booming, which is why Clayton and SEC commissioners have taken up the matter. They are trying to determine if a vehicle could be created to open such securities to small investors. Last year, companies in the private market raised roughly $3 trillion while public companies raised $1.8 trillion.

Market participants point out the gains are often greater in the trading of pre-IPOs shares than some recent prominent initial public offerings, such as ride-share provider Uber, which has floundered in its public debut after racking up huge gains when Uber private shares traded in the pre-IPO market.

"The SEC is seriously considering approving a new investment vehicle for private shares," John Coffee, a Columbia law school professor who specializes in financial issues, said.

“The mechanics are unclear but the SEC can either ask Congress for legislation or adopt a rule that exempts its new vehicle from the Investment Company Act of 1940,” Coffee added.

An SEC spokesman declined comment.

The SEC’s talks center on passing a rule that would create a new investment vehicle that mirrors a hedge fund. But unlike hedge funds, it would be open to non-accredited investors, according to people with knowledge of the discussions. Small investors would gain access to the private market by going through this fund-like vehicle, which would be comprised of a diversified portfolio of pre-IPO companies in order to reduce investment risk.

But not all market participants believe the effort is a good idea. The SEC would demand additional disclosures from the companies themselves, thus making the companies less likely to issue private shares, much less public shares. The reason many companies are opting to remain in the private market for years is the less stringent disclosure requirement mandated by the SEC because investors are considered more sophisticated than so-called mom-and-pop retail purchasers of stock.

“Part of why private companies can enjoy accelerated growth is that they are free from the regulatory burden public companies face. In addition, they are more efficient because their management teams are not beholden to quarterly earnings and compensated based on a public share price,” said Omeed Malik, the founder and CEO of Farvahar Partners, a broker-dealer specializing in the private stock market.

“Allowing Main Street to invest in privately traded companies sounds nice but the road to hell is paved with good intentions,” Malik said in an interview on FBN’s Cavuto Coast to Coast. “Allowing retailer investors to participate in private placement is a noble sentiment … but there are significant ramifications,” he said in a subsequent interview.

Because the private markets have fewer regulations than public markets, some analysts fear retail investors could be putting themselves at greater risk without fully understanding the volatility of pre-IPO companies. While there may be opportunities in private markets, investors are not insulated from losses just because they get in on a company’s stock earlier.

Clayton has made serving the needs of small investors a centerpiece of his agenda as SEC chairman, and people close to the commission say he’s intent on opening the private market to small investors as part of that effort.

In a Sept. 9 speech at the Economic Club of New York meeting, Clayton said, “Twenty-five years ago, the public markets dominated the private markets in virtually every measure.  Today, in many measures, the private markets outpace the public markets, including in aggregate size.”

 

For discussion:

·        Do you support this idea that the pre-IPO shares should be available to all investors. Is that possible?

 

 

Homework ( DUE with first midterm exam)

1.     Check three stocks listed above in the IPO table.

·        Follow these stocks and report their performances one month after the IPO.

·        Summarize your findings.   

2)   Tesla is selling at $370 per share as of 9/10/2020. Do you suggest investing in Tesla? Why or why not?

3) Tesla will issue new shares called secondary public offering (SEO). What is the impact on stock price by this new offering?  Why?

 

image018.jpg

 

Tesla Stock’s 3 Big Issues After The Stock Split

For discussion: Now under $400. Time to buy?

 

John NavinContributor

It’s hard to complain about stocks that go straight up, more or less, in price. It’s the dream of every investor to find them and then to brag endlessly about their genius in identifying them. Tesla TSLA +10.9% is the latest example of slightly crazed buying in a single equity that nothing can hold back.

There’s no question that CEO Elon Musk is one of the great business innovators, creating the first no-gasoline-needed car that found a market and established a brand name. Those short sellers who question Tesla’s long-term prospects keep getting frustrated by the stock’s ability to keep reaching the sky.

cars travel automakers renewables

Tesla monthly price chart, 8 29 20.

 STOCKCHARTS.COM

Monday’s stock split is a meaningless exercise: investors end up with more shares for the same amount of money. Big deal. Tesla gets a few headlines but nothing of substance is accomplished from the standpoint of profitability or growth.

Meantime, here are 3 issues many of the car company’s most enthusiastic supporters seem to want to ignore.

Tesla’s price/earnings ratio is insanely and ridiculously high: 1,100. Come on now. The forward p/e, based on something called “expected earnings,” is a mere 140, of course, but how much more reasonable is that, really?

The Shiller p/e of the Standard and Poor’s 500 now sits at 30 which by itself is historically on the “rather high” side to begin with. The price/earnings ratio for Apple AAPL +4% is 38. Microsoft MSFT +4.3% is coming in these days at 39.

Tesla’s multiple of 1,100 suggests investors believe that Elon Musk will be bringing back gold from his mines on Mars by sometime next year and that the value of the metals will be showing up on the company’s bottom line right away.

This is not to say the price/earnings ratios are the key to investing. It’s just one metric among many for determining valuation, but it’s the most classically used of the metrics from Benjamin Graham and Warren Buffett on down.

Competition to Tesla is here and it’s been here for awhile. High-end and middle-brow electric and hybrid gas/electric powered can be purchased from a number of established car makers.

Ford, General Motors GM -1.3% and Honda are involved. Those taking direct aim at the firm Tesla grip on the real luxury market include Porsche with the Taycan — and Lexus with their ES Hybrid.

While Musk has created the name brand that seems to most clearly identify newness and style, history tends to demonstrate that others eventually take on and meet the challenge of offering marketable alternatives to the original concept.

Some Tesla investors have difficulty even comprehending the idea of actual competition to their favorite, highly-profitable portfolio addition. It may take months or years but highly competitive operations are underway to grab market share away.

Hot stock syndrome. If you’ve been around for a few years, you’ve seen this before: during the most heated phase of a bull market, one stock becomes so highly recognized as the hottest one that everyone you meet knows its name and the basics of its story. Right now, that’s Tesla.

Inside the Wall Street community and outside, it’s the growth stock to end all growth stocks. Since it just keeps going up (so far), analysts are pressured to include it among their “buy” recommendations, so as not to be left behind.

Robinhood traders, many of them new to the stock market and to trading, find in Tesla their dream of apparently endless profits. They have yet to experience the other side of a bull market and confidently go in with much less caution than might be merited.

carmakers travel energy

Tesla daily price chart, 8 29 20.

 STOCKCHARTS.COM

On the arrival of Tesla’s 5-for-1 stock split, it’s probably wise to take these factors into consideration. Can it keep going up in price despite all of this? Of course it can. Hot stocks have a way of continuing upward despite all obstacles until, finally, they don’t — welcome to the stock market.

 

 

Sell up to $5 billion in stock amid its incredible rally

PUBLISHED TUE, SEP 1 20207:22 AM EDTUPDATED TUE, SEP 1 20204:06 PM EDT

Pippa Stevens@PIPPASTEVENS13

KEY POINTS

          Amid Tesla’s record rise that has seen shares soar to new highs, the company said it will sell up to $5 billion in stock.

          The additional shares will be sold “from time to time” and “at-the-market” prices, Tesla said in an SEC filing.

          It said banks will sell shares based on directives from Tesla.

          Through Monday’s close, the electric car maker has gained nearly 500% in 2020.

Amid Tesla’s incredible rise that has seen shares soar to new highs, the electric auto maker said Tuesday it will sell up to $5 billion in new stock.

The additional shares will be sold “from time to time” and “at-the-market” prices, Tesla said in a filing with the Securities and Exchange Commission. It said banks will sell shares based on directives from Tesla.

“We intend to use the net proceeds, if any, from this offering to further strengthen our balance sheet, as well as for general corporate purposes,” Tesla said.

The stock briefly traded in the green on Tuesday, but moved lower throughout afternoon trading and ended the session 4.67% lower.

The decline hardly dents shares’ rapid appreciation this year. Through Monday’s close, the electric car maker has gained nearly 500% in 2020. In the last year, shares have gained 1,004% compared with the S&P 500′s 20% rise.

Tesla’s run-up has only gained steam since the company announced its 5-for-1 stock split on Aug. 11. In that time, Tesla shares have rallied 81.3%. That gain includes a 12.6% pop on Monday, when the split took effect. That rise came even though stock splits are purely cosmetic, meaning nothing about the company’s underlying business changes.

Tesla’s market cap now stands around $464 billion meaning the new offering represents about 1% of the company’s value, according to FactSet.

Wedbush analyst Dan Ives called the capital raise a “smart move,” citing strong appetite among investors to “play the transformational EV trend through pure play Tesla over the coming years.”

CEO Elon Musk is “raising enough capital to get the balance sheet and capital structure to further firm up its growing cash position and slowly get out of its debt situation, which throws the lingering bear thesis for Tesla out the window for now,” Ives added. Wedbush has a neutral rating on the stock and a base target of $380.

Part of Tesla’s share appreciation is due to the company reporting its fourth straight quarter of profits in its July 22 report, which qualifies the electric auto maker for inclusion in the S&P 500. Tesla also posted better-than-expected second-quarter vehicle deliveries.

Still, the rate at which investors have piled into the company has left many on the Street puzzled.

Miller Tabak chief market strategist Matt Maley warned that shares are due for a pullback. Those “who buy stock in TSLA on the new $5bn equity distribution they announced this morning are going to get burned,” he said.

“Even if this stock rallies a bit more over the next week or two, it’s going to be trading at least 30% below today’s level before the end of the year in our opinion,” he added.

On Monday night, RBC reiterated its underperform rating on the stock, calling the automaker “fundamentally overvalued.” However, the firm did raise its price target from $170 to $290.

Tesla last tapped capital markets in February, when it announced a $2 billion common stock offering. The announcement came just two weeks after Musk said during the company’s fourth quarter earnings call that he had no intention of raising capital.

“We’re spending money as quickly as we can spend it sensibly,” Musk said on Jan. 29. “We are not artificially limiting our progress. Despite all that, we are still generating positive cash. In light of that, it doesn’t make sense to raise money because we expect to generate cash despite this growth level.”

- CNBC’s Fred Imbert contributed reporting.

 

 

 

Chapter 4: Future value, Present Value, and Interest Rate

 

 Ppt

 

image007.jpg

image008.jpg

Example1: A 5 year, 5% coupon bond, currently provides an annual return of 3%. Calculate the price of the bond.

Example 2: Your cousin is entering medical school next fall and asks you for financial help. He needs $65,000 each year for the first two years. After that, he is in residency for two years and will be able to pay you back $10,000 each year. Then he graduates and becomes a fully qualified doctor, and will be able to pay you $40,000 each year. He promises to pay you $40,000 for 5 years after he graduates. Are you taking a financial loss or gain by helping him out? Assume that the interest rate is 5% and that there is no risk.

Example 3: You are awarded $500,000 in a lawsuit, payable immediately. The defendant makes a counteroffer of $50,000 per year for the first three years, starting at the end of the first year, followed by $60,000 per year for the next 10 years. Should you accept the offer if the discount rate is 12%? How about if the discount rate is 8%?

Example 4: John is 30 years old at the beginning of the new millennium and is thinking about getting an MBA. John is currently making $40,000 per year and expects the same for the remainder of his working years (until age 65). I f he goes to a business school, he gives up his income for two years and, in addition, pays $20,000 per year for tuition. In return, John expects an increase in his salary after his MBA is completed. Suppose that the post-graduation salary increases at a 5% per year and that the discount rate is 8%. What is miminum expected starting salary after graduation that makes going to a business school a positive-NPV investment for John? For simplicity, assume that all cash flows occur at the end of each year

 

Homework (just write down the PV equations – Due with the first mid term exam):

1. The Thailand Co. is considering the purchase of some new equipment. The quote consists of a quarterly payment of $4,740 for 10 years at 6.5 percent interest. What is the purchase price of the equipment? ($138,617.88)

2. The condominium at the beach that you want to buy costs $249,500. You plan to make a cash down payment of 20 percent and finance the balance over 10 years at 6.75 percent. What will be the amount of your monthly mortgage payment? ($2,291.89)

3. Today, you are purchasing a 15-year, 8 percent annuity at a cost of $70,000. The annuity will pay annual payments. What is the amount of each payment? ($8,178.07)

 

4. Shannon wants to have $10,000 in an investment account three years from now. The account will pay 0.4 percent interest per month. If Shannon saves money every month, starting one month from now, how much will she have to save each month? ($258.81)

5. Trevor's Tires is offering a set of 4 premium tires on sale for $450. The credit terms are 24 months at $20 per month. What is the interest rate on this offer? (6.27 percent)

6. Top Quality Investments will pay you $2,000 a year for 25 years in exchange for $19,000 today. What interest rate are you earning on this annuity? (9.42 percent)

7. You have just won the lottery! You can receive $10,000 a year for 8 years or $57,000 as a lump sum payment today. What is the interest rate on the annuity? (8.22 percent)

Summary of math and excel equations

Math Equations 

FV = PV *(1+r)^n

PV = FV / ((1+r)^n)

N = ln(FV/PV) / ln(1+r)

Rate = (FV/PV)1/n -1

Annuity: N = ln(FV/C*r+1)/(ln(1+r))

Or N = ln(1/(1-(PV/C)*r)))/ (ln(1+r))

 

EAR = (1+APR/m)^m-1

APR = (1+EAR)^(1/m)*m

 

image005.jpg

 

 

 

 

NPV NFV calculator:

www.jufinance.com/nfv

 

·       9/17 First Mid Term from 11am to 3pm

·       Take it online

·       50 T/F questions

·       Will be Posted on course introduction on blackboard

 

 

 

Chapter 6 Bond Market

 

Chapter 6 PPT

 

1.      Cash flow of bonds

image009.jpg

 

 

For example: a 3 year bond 10% coupon rate, draw its cash flow.

Introduction to bond investing (video)

How Bonds Work (video)

 

2.      Risk of Bonds

Class discussion: Is bond market risky?

Bond risk (video)

Bond risk – credit risk (video)

Bond risk – interest rate risk (video)

Bond risk – how to reduce your risk (video)

 

3.      Choices of investment in bonds

 

FINRA – Bond market information

http://finra-markets.morningstar.com/BondCenter/Default.jsp

 

Treasury Bond Auction and Market information

http://www.treasurydirect.gov/

 

Treasury Bond

Corporate Bond

Municipal Bond

International Bond

Bond Mutual Fund

TIPs

Class discussion Topic I: As a college student, which type of bonds shall you buy? Why?

 

Class discussion Topics II

 

You can invest in junk bonds. Shall you? Or shall you not?

What is a high yield bond (Video)

Definition: A high yield bond – also known as a junk bond – is a debt security issued by companies or private equity concerns, where the debt has lower than investment grade ratings. It is a major component – along with leveraged loans – of the leveraged finance market.(www.highyieldbond.com)

 

Everything You Need to Know About Junk Bonds (video)

Updated Aug 17, 2019

 

For many investors, the term "junk bond" evokes thoughts of investment scams and high-flying financiers of the 1980s, such as Ivan Boesky and Michael Milken, who were known as "junk-bond kings." But don't let the term fool you—if you own a bond fund, these worthless-sounding investments may have already found their way into your portfolio. Here's what you need to know about junk bonds.

Junk Bonds

From a technical viewpoint, a junk bond is exactly the same as a regular bond. Junk bonds are an IOU from a corporation or organization that states the amount it will pay you back (principal), the date it will pay you back (maturity date), and the interest (coupon) it will pay you on the borrowed money.

Junk bonds differ because of their issuers' credit quality. All bonds are characterized according to this credit quality and therefore fall into one of two bond categories:

Investment Grade – These bonds are issued by low- to medium-risk lenders. A bond rating on investment-grade debt usually ranges from AAA to BBB. Investment-grade bonds might not offer huge returns, but the risk of the borrower defaulting on interest payments is much smaller.

  • Junk Bonds – These are the bonds that pay high yield to bondholders because the borrowers don't have any other option. Their credit ratings are less than pristine, making it difficult for them to acquire capital at an inexpensive cost. Junk bonds are typically rated 'BB' or lower by Standard & Poor's and 'Ba' or lower by Moody’s.
  • Think of a bond rating as the report card for a company's credit rating. Blue-chip firms that provide a safer investment have a high rating, while risky companies have a low rating. The chart below illustrates the different bond-rating scales from the two major rating agencies, Moody's and Standard & Poor's:

Although junk bonds pay high yields, they also carry a higher-than-average risk that the company will default on the bond. Historically, average yields on junk bonds have been 4% to 6% above those for comparable U.S. Treasuries.

Junk bonds can be broken down into two other categories:

  • Fallen Angels – This is a bond that was once investment grade but has since been reduced to junk-bond status because of the issuing company's poor credit quality.
  • Rising Stars – The opposite of a fallen angel, this is a bond with a rating that has been increased because of the issuing company's improving credit quality. A rising star may still be a junk bond, but it's on its way to being investment quality.

 

 

Who Buys Junk Bonds?

You need to know a few things before you run out and tell your broker to buy all the junk bonds he can find. The obvious caveat is that junk bonds are high risk. With this bond type, you risk the chance that you will never get your money back. Secondly, investing in junk bonds requires a high degree of analytical skills, particularly knowledge of specialized credit. Short and sweet, investing directly in junk is mainly for rich and motivated individuals. This market is overwhelmingly dominated by institutional investors.

This isn't to say that junk-bond investing is strictly for the wealthy. For many individual investors, using a high-yield bond fund makes a lot of sense. Not only do these funds allow you to take advantage of professionals who spend their entire day researching junk bonds, but these funds also lower your risk by diversifying your investments across different asset types. One important note: know how long you can commit your cash before you decide to buy a junk fund. Many junk bond funds do not allow investors to cash out for one to two years.

Also, there comes a point in time when the rewards of junk bonds don't justify the risks. Any individual investor can determine this by looking at the yield spread between junk bonds and U.S. Treasuries. As we already mentioned, the yield on junk is historically 4% to 6% above Treasuries. If you notice the yield spread shrinking below 4%, then it probably isn't the best time to invest in junk bonds. Another thing to look for is the default rate on junk bonds. An easy way to track this is by checking the Moody's website.

The final warning is that junk bonds are not much different than equities in that they follow boom and bust cycles. In the early 1990s, many bond funds earned upwards of 30% annual returns, but a flood of defaults can cause these funds to produce stunning negative returns.

The Bottom Line

Despite their name, junk bonds can be valuable investments for informed investors, but their potential high returns come with the potential for high risk.

 

image011.jpg 

 

 

For discussion:

·        What type of investors should buy high yield bond?

·        What do Moody bond ratings mean?

·        How do Moody and other rating agencies rate bonds?

 

 

Rising defaults in high-yield bonds puts this year on track for postcrisis record, warns Goldman Sachs 8/18/2019

Defaults reach above 5%, from 1.3% bottom in November 2018

 

By JOYWILTERMUTH

Defaults on bonds issued by debt-laden U.S. companies with speculative-grade ratings are on pace to reach a new high this year for the post 2008 crisis era, according to Goldman Sachs analysts.

The bank has tracked more than $36 billion of defaulted so-called junk bonds already in 2019, and there are likely to be more, particularly in the energy sector, to eclipse the prior post crisis default record of $43 billion in 2016, wrote Goldman analysts led by Lotfi Karoui in a Thursday note to clients.

Thus far, defaults have been highly concentrated among energy issuers, a trend that reflects structural as opposed to cyclical challenges, the Goldman analysts wrote. The lingering weakness in oil prices coupled with weak growth sentiment may push issuers in other structurally-challenged sectors toward defaults.

Oil field servicing company Weatherford International Ltd WFTIQ, -8.67%, which filed for bankruptcy with $7.4 billion of high-yield debt, is the years second-largest default, after the massive default of Californias Pacific Gas and Electric Company PCG, +5.80%  on $18.3 billion of debt in January, according to Moodys Investors Service.

In the case of Weatherford, Moodys said it expects to see bond recoveries of 35%-65% on roughly $5.85 billion of debt that the company hopes to slash through its restructuring.

PG&E was considered an investment-grade credit, until it filed for bankruptcy following devastating California wildfires in 2017 and 20180 left it facing billions in potential liabilities.

This chart shows the dollar amount of defaulted U.S. high-yield bonds thus far in 2019, which is approaching levels not seen since 2016, after Brent crude oil prices plunged below $35 per barrel and put significant pressure on the financial conditions of oil companies and exporters.

https://ei.marketwatch.com/Multimedia/2019/08/16/Photos/NS/MW-HP633_GS__HY_20190816121801_NS.jpg?uuid=6b2736ea-c041-11e9-90b7-9c8e992d421eGoldman Sachs

Energy adding to rising high-yield defaults

Moodys said this week in a separate report that junk-bonds issued by companies in July came with the worst protections yet for investors.

Check outJunk bonds are getting worse and investors are starting to take notice

At present, the three-month trailing high-yield bond default rate is above 5% on an annualized basis, a sharp jump from its 1.3% bottom in November 2018, according to Goldman analysts.

By comparison, the default rate traveled north of 14% for U.S. high-yield bonds in the aftermath of the 2007-2008 global financial crisis, according to Moodys, which said in July that its baseline forecast was for defaults to stay below 4% through July 2020.

Goldman analysts also dont see defaults moving meaningfully higher from current levels, absent a full-blown recession, which the banks U.S. economics team doesnt anticipate occurring in the near term.

Recession and trade war jitters rattled U.S. stocks this week, although the major benchmarks managed to close higher on Friday, with the Dow Jones Industrial Average DJIA, -0.36% adding 300 points, and the S&P 500 index SPX, -0.45% gaining 41 points and the Nasdaq Composite Index COMP, -0.33%   increasing by 308 points.

Investors have plenty of high-risk and so-called grey swan events to watch for, as the third quarter draws closer.

In high-yield, a big focus will be corporate earnings through year-end. Companies can end up in default when earnings slump, making it harder for borrowers to keep up on debt payments.

And with energy making up 14% of the closely-tracked Bloomberg Barclays U.S. high-yield bond Index, Oxford Economics is keeping a close eye on the fortunes of energy companies.

Our main source of worry is the fact that the improvement in U.S. fundamentals since 2017 can be entirely attributed to the energy sector,wrote Michiel Tukker, Oxford Economics global strategist in a note Friday.

It is telling that oil hasnt risen despite OPEC cuts and tensions in the Gulf of Hormuz, Tukker added.

October Brent crude UK:BRNV19  finished up 0.7% on Friday to $58.64 a barrel on ICE Futures Europe, but was still sharply down from its two-year high of $86.29 on October 3, 2018, according to FactSet data.

Whats more, Tukker found that 18% of U.S. high-yield companies recently reported negative hearings, the highest since the global financial crisis outside of the oil price collapse in 2014 and 2015.

Tukker said that could drag down the sectors debt interest coverage ratios, a measure of corporate earnings to interest expenses.

With earnings outlook gloomy, we expect the ratio to fall significantly going forward, bringing interest coverage ratios down rapidly.

 

Home Work chapter 6 (due with the second mid term exam):

1. Draw cash flow  graph of a bond with 5 years left to  maturity 5% coupon rate.

2. Find Wal-Mart bond in FINRA website. Find Microsoft bond with similar maturity date: http://finra-markets.morningstar.com/BondCenter/Default.jsp

·         Which company’s bond is riskier? Why?

·         What is the rating of each company’s bond?

·         Do you agree with the ratings given by the rating agencies?

3. As a bond investor, do you plan to invest in junk bond? Why or why not?

4. Among stocks, investment grade bonds, and high yield bonds, which one do you want to invest in? Why? Please refer to the articles read in class.

 

year

high yield bond

investment grade bond

stock

1980

-1.00%

2.71%

32.50%

1981

7.56%

6.26%

-4.92%

1982

32.45%

32.65%

21.55%

1983

21.80%

8.19%

22.56%

1984

8.50%

15.15%

6.27%

1985

26.08%

22.13%

31.73%

1986

16.50%

15.30%

18.67%

1987

4.57%

2.75%

5.25%

1988

15.25%

7.89%

16.61%

1989

1.98

14.53%

31.69%

1990

-8.46%

8.96%

-3.11%

1991

43.23%

16.00%

30.47%

1992

18.29%

7.40%

7.62%

1993

18.33%

9.75%

10.08%

1994

-2.55%

-2.92%

1.32%

1995

22.40%

18.46%

37.58%

1996

11.24%

3.64%

22.96%

1997

14.27%

9.64%

33.36%

1998

4.04%

8.70%

28.58%

1999

1.73%

-0.82%

21.04%

2000

-5.68%

11.63%

-9.11%

2001

5.44%

8.43%

-11.89%

2002

-1.53%

10.26%

-22.10%

2003

27.94%

4.10%

28.68%

2004

11.95%

4.34%

10.88%

2005

2.26%

2.43%

4.91%

2006

11.92%

4.33%

15.79%

2007

2.65%

6.97%

5.49%

2008

-26.17%

5.24%

-37.00%

2009

54.22%

5.93%

26.46%

2010

14.42%

6.54%

15.06%

2011

5.47%

7.84%

2.11%

2012

14.72%

4.22%

16.00%

2013

7.53%

-2.02%

32.39%

average

16.98%

8.43%

13.22%

standard deviation

35.25%

7.02%

17.22%

kurtosis

22.15

3.30

0.87

Skewness

4.31

1.37

-0.92

 

5. Fed reduced interest rate. Do you think that it is safer to invest in junk bond when interest rates are low? Or just the opposite? Why or why not?

 

 

Historical Performance Data of High-Yield Bonds

Year-by-Year Total Returns From 1980 Through 2013

https://www.thebalance.com/high-yield-bonds-historical-performance-data-417116

BY THOMAS KENNY

 

Updated February 11, 2019

 

Its extremely challenging to find year-by-year returns for the high-yield bond market, and that's odd when you think about it. This is an asset class with a great deal of money invested in it. If you're interested in seeing how high-yield bonds have performed over time, this table shows the return for the category each year from 1980 through 2013. It includes its performance relative to stocks as gauged by the S&P 500 Index, and relative to investment-grade bonds as measured by the Barclays Aggregate Bond Index.

 

High yield returns are represented by the Salomon Smith Barney High Yield Composite Index from 1980 through 2002, and the Credit Suisse High Yield Index from 2003 onward.

Year

HY Bonds

Investment-Grade

Stocks

1980

-1.00%

2.71%

32.50%

1981

7.56%

6.26%

-4.92%

1982

32.45%

32.65%

21.55%

1983

21.80%

8.19%

22.56%

1984

8.50%

15.15%

6.27%

1985

26.08%

22.13%

31.73%

1986

16.50%

15.30%

18.67%

1987

4.57%

2.75%

5.25%

1988

15.25%

7.89%

16.61%

1989

1.98

14.53%

31.69%

1990

-8.46%

8.96%

-3.11%

1991

43.23%

16.00%

30.47%

1992

18.29%

7.40%

7.62%

1993

18.33%

9.75%

10.08%

1994

-2.55%

-2.92%

1.32%

1995

22.40%

18.46%

37.58%

1996

11.24%

3.64%

22.96%

1997

14.27%

9.64%

33.36%

1998

4.04%

8.70%

28.58%

1999

1.73%

-0.82%

21.04%

2000

-5.68%

11.63%

-9.11%

2001

5.44%

8.43%

-11.89%

2002

-1.53%

10.26%

-22.10%

2003

27.94%

4.10%

28.68%

2004

11.95%

4.34%

10.88%

2005

2.26%

2.43%

4.91%

2006

11.92%

4.33%

15.79%

2007

2.65%

6.97%

5.49%

2008

-26.17%

5.24%

-37.00%

2009

54.22%

5.93%

26.46%

2010

14.42%

6.54%

15.06%

2011

5.47%

7.84%

2.11%

2012

14.72%

4.22%

16.00%

2013

7.53%

-2.02%

32.39%

 

Keep  a few historical factors in perspective when you're looking at these returns. First, there was a much higher representation of fallen angels”—former issues that fell into below-investment-grade territoryin the early days of the high-yield  investment-grade market than there is today. There was a corresponding lower representation of issues from the type of smaller companies that make up the bulk of the market now.

 

Second, all the down years for high yield were accompanied by the economic slowdowns in 1980, 1990, 1994, and 2000, or by financial crises in 2002 and 2008.

 

Third, yields were much higher in the past than they are today. While absolute yields spent much of the 20122013 period below 7.5 percent and they reached as low as the 5.2 to 5.4 percent range in April and May 2013, these levels would have been unheard of in prior years. The 19801990 period generally saw yields in the mid-teens. Even at the lows of the late 1990s, high-yield bonds still yielded 8 to 9 percent. During the 20042007 interval, yields hovered near the 7.5 to 8 percent level, which were record lows at the time.

 

High-yield bonds also paid a much higher yield than they do now.

 

The takeaway is twofold. High-yield bonds had higher return potential due to the larger contribution from yield to total return, and there was more room for price appreciation. Remember that bond prices and yields move in opposite directions. As a result, people who invest in the asset class today shouldnt expect a repeat of the type of returns shown above. Still, these numbers show that high-yield bonds have delivered very competitive returns over time. 

 

 

 The Party’s Almost Over, Say High-Yield Bond Investors

By Erik Sherman, July 15, 2019

The high-yield party has been raging. But investors who stick around may have one heck of a hangover.

In recent weeks, the difference in yields between high-grade investment or government bonds and low-grade, high-yield corporate bonds dropped to 375 basis points. Often called junk bonds, companies with low credit raimage032.jpgtings issue high-yield bonds for access to capital, although at a higher interest rate than companies with good credit.

But risk needs the right amount of reward. The shift in yields meant only 0.375% in interest now separates the safest bond investments from those issued by companies with poorer credit (and a higher risk of default). Given the narrowing yield spread, several prominent portfolio managers have decided it's time to count their winnings and bail on high-yield bonds.

"As a credit debt holder, you've got no upside, you only have downside [at this point]," says Pilar Gomez-Bravo, director of fixed income Europe for MFS Investment Management. Even if technical signals seem to indicate a rally, "at some stage you want to be prudent in your risk taking with levels you're getting paid for. You enjoy the party, the rally, the momentum, but you have to be diligent." Back in 2016, 30% of the portfolio she oversees was high-yield. Now that's down to 10%.

Getting nervous

"There is an expectation that the economy is slowing in the United States" and around the globe, said Troy Snider, investment adviser and principal at Bartlett Wealth Management. The possibility of a rate cut in the Fed's July meeting is seen as proof and the Fed funds futures are showing a 100% expectation of a cut then, according to a Fortune review of data from Bloomberg. That means investors think the Fed will respond to what it sees as a slowing economy by dropping rates in a stimulus attempt.

A slowing economy tends to be disproportionately hard on high-yield bonds. The amount of interest companies have to pay for new bonds, be it the first issuance or to roll over and pay off old bonds, shoots up. Now there's more money to be made by investors in buying a newly issued bond rather than purchasing an existing one from a current holder. Investors who already hold bonds can find themselves unable to offload existing holdings, as the market chases more profitable assets.

"You kind of think about it as a hill," said Jeff Garden, chief investment officer of Lido Advisors. "On the way up, when rates are low, it's great because [the low rates are] stimulating the economy and promoting growth. Things are looking up. The cost of business is cheap." But once at the top, things again go downhill, with a slowing economy and increasing rates. That worries investors—who doesn't like the good times to continue?—and they now assume that additional rate cuts are more signs of a slowdown.

This has left high-yield bonds are in an agitated state. In May, $7 billion was pulled out of high-risk bonds, which shouldn't matter in a trillion-dollar or larger market, according to Karissa McDonough, fixed income strategist at People's United Advisors. A trading day that saw $10 billion shifts would be considered normal, she said.

But investors still reacted strongly. As a result, the interest spread between high-yield bonds and time-matched Treasurys went up by 100 basis points, or 1 percentage point, within six weeks. "The spread reflects the extra yield that investors demand for a high yield bond instead of an asset like a Treasury bond," she said.

Then in June, Powel signaled the Fed's dovish position toward rates and another $7 billion came back into that market. Within a few weeks, the spread dropped again by 70 basis points. "The idea that some small amount flowing [into or out of] the market could move it to that degree tells you is this asset class is very, very sensitive to liquidity and fund flows and investor sentiment," McDonough said.

Risk goes up

The potential for rapid and nervous reaction now creates a risk in the higher-yield and junk bond markets. The companies issuing the bonds typically expect to roll them over, taking on new bond issuance and investors to pay off the earlier batch. "If the market pulls back and capital is not as easily accessible to these companies, it's difficult to roll over," McDonough said.

That could drive up default rates, which hurt the overall results in any portfolio, because the greater the number of defaults the lower the average returns. At the same time, there is the dichotomy between the bond markets and equities, which are high on assumptions of Fed rescue with rate drops.

"Something is about to break [in the economy] and that's why the Fed is cutting rates," Gomez-Bravo said. "When you take that in the context of the credit market, you have to overlay [whether you are] getting paid for default risk, for downgrade risk."

"Our fixed income holdings have almost exclusively been high-yield for the better part of a decade," said Patrick McDowell, a portfolio manager at Arbor Wealth Management. "We’ve done well with the strategy relative to other types of fixed income. But we are dramatically slowing our purchases."

Or, as Garden put it, "At this point in the year, when I look at the numbers, I see no reason to hold onto them. I've had a very, very healthy return, one that I don't expect to continue for the next six to 12 months. I don't expect the magnitude and trajectory of returns that I've seen over the past few months to continue, so why bother?"

Some managers say that dumping all high-yield bonds may not be necessary, but investors have to pick and choose carefully and not depend on a high-yield bond ETF, an investment fund type focused on high-yield bonds and often popular with investors who want better performance than available in government bonds. "It's time to be very selective," Gomez-Bravo said. "If you're going to have high yield, choose the idiosyncratic risk that you like."

And don't forget to have aspirin at hand the next morning. Just in case.

 

For discussion:

·        Why during the economy downturn, it is suggested not to invest in high yield bond?

·        What is the spread between high yield bond and investment grade bond?

·        How to pick high yield bond? What is high yield bond ETF? 

 

 

Chapter 7 Rating, Term structure

 

Part I: Credit Rating Agency

 

Chapter 7 Rating Agency, Interest rate risk, yield curve (PPT)

 

The Big Short - Standard and Poors scene --- This is how they worked

·         Found any conflict of interest between the investment bank and S&P?

·         Who acts in good conscience, the lady representing the rating agency, or the Investment Banker?

 

Three Major Rating Agencies

University: Bond rating (video)

Moody’s sovereign rating list

 

For class discussion

 

o   Who are they?

o   Are they private firms or government agencies?

o   How bonds are rated?

o   Do we need rating agencies? Do you trust their ratings?

 

 image012.jpg

 

 

 

Category

Definition

 

AAA

An obligation rated 'AAA' has the highest rating assigned by Standard & Poor's. The obligor's capacity to meet its financial commitment on the obligation is extremely strong.

 

AA

An obligation rated 'AA' differs from the highest-rated obligations only to a small degree. The obligor's capacity to meet its financial commitment on the obligation is very strong.

 

A

An obligation rated 'A' is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligations in higher-rated categories. However, the obligor's capacity to meet its financial commitment on the obligation is still strong.

 

BBB

An obligation rated 'BBB' exhibits adequate protection parameters. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation.

 

Obligations rated 'BB', 'B', 'CCC', 'CC', and 'C' are regarded as having significant speculative characteristics. 'BB' indicates the least degree of speculation and 'C' the highest. While such obligations will likely have some quality and protective characteristics, these may be outweighed by large uncertainties or major exposures to adverse conditions.

 

 

 

 

 

 

 

 

CCC

 An obligation rated 'CCC' is currently vulnerable to nonpayment, and is dependent upon favorable business, financial, and economic conditions for the obligor to meet its financial commitment on the obligation. In the event of adverse business, financial, or economic conditions, the obligor is not likely to have the capacity to meet its financial commitment on the obligation.

 

 For class discussion:

Why would an investor buy junk bond?

 

 

Sovereigns Rating (http://countryeconomy.com/ratings/) – The lowest and the highest – Most recent

Country

S&P

Moody's

Fitch

Hong Kong

AAA

Aa1

AA+

Isle of Man

N/A

Aa1

 

Australia

AAA

Aaa

AAA

Canada

AAA

Aaa

AAA

Denmark

AAA

Aaa

AAA

Germany

AAA

Aaa

AAA

Luxembourg

AAA

Aaa

AAA

Netherlands

AAA

Aaa

AAA

Norway

AAA

Aaa

AAA

Singapore

AAA

Aaa

AAA

Sweden

AAA

Aaa

AAA

Switzerland

AAA

Aaa

AAA

Barbados

B-

Caa1

 

Belarus

B-

Caa1

B-

Jamaica

B

Caa2

B

Belize

B-

Caa2

 

Cuba

 

Caa2

 

Greece

B-

Caa3

CCC

Ukraine

B-

Caa3

CCC

Mozambique

CCC

Caa3

CC

Venezuela

CCC

Caa3

CCC

 

 

Class discussion Topics

·        How much do you trust those rating agencies?

·        Are those rating agencies private or public firms?

·        What factors should be considered when a rating agency is evaluating a debt?

 

How credit agencies work(video)

Rating Conflicts (video) https://www.youtube.com/watch?v=-C5JW4I3nfU

 

FYI: The functions of rating agencies

 

 

Part II: Z Scores

 

How the credits are assigned? (word file)

 

Altman Z score (video)

 

The Coming Tesla Bankruptcy: An Altman Z-Score Analysis

 

 

 

The Altman Z-Score Formula (https://www.investopedia.com/terms/z/zscore.asp)

 

image047.jpg

The Altman Z-score is the output of a credit-strength test that helps gauge the likelihood of bankruptcy for a publicly traded manufacturing company. The Z-score is based on five key financial ratios that can be found and calculated from a company's annual 10-K report. The calculation used to determine the Altman Z-score is as follows:

ζ=1.2A+1.4B+3.3C+0.6D+1.0E

where: Zeta(ζ)=The Altman Z-score

A=Working capital/total assets

B=Retained earnings/total assets

C=Earnings before interest and taxes (EBIT)/totalassets

D=Market value of equity/book value of total liabilities

E=Sales/total assets

Typically, a score below 1.8 indicates that a company is likely heading for or is under the weight of bankruptcy. Conversely, companies that score above 3 are less likely to experience bankruptcy.

 

From http://www.altmanzscoreplus.com/articles/AltmanZScorePlus_TSLA_Tesla_Motors_Inc.html


Evolution of Z-Series Scores

The Z-score formula for predicting bankruptcy was published in 1968 by Dr. Edward I. Altman, who was, at the time, an Assistant Professor of Finance at New York University. The formula may be used to predict the probability that a firm will go into bankruptcy within two years. Z-scores are used to predict corporate defaults and an easy-to-calculate control measure for the financial distress status of companies in academic studies. The Z-score uses multiple corporate income and balance sheet values to measure the financial health of a company.

The Z-score is a linear combination of four or five common business ratios, weighted by coefficients. The coefficients were estimated by identifying a set of firms which had declared bankruptcy and then collecting a matched sample of firms which had survived, with matching by industry and approximate size (assets). Professor Altman applied the statistical method of discriminant analysis to a dataset of publicly held manufacturers. The estimation was originally based on data from publicly held manufacturers, but has since been re-estimated based on other datasets for private manufacturing, non-manufacturing and service companies. Z-Score applies to US Manufacturing companies, Z'-Score applies to US Private Manufacturing companies, and Z"-Score applies to all other companies (US Non-Manufacturing and all Non-US companies). The original data sample consisted of 66 firms, half of which had filed for bankruptcy under Chapter 7. All businesses in the database were manufacturers, and small firms with assets of less than $1 million were eliminated. Dr. Altman found that the ratio profile for the bankrupt group fell at -0.25 average, and for the non-bankrupt group at +4.48 average.

Classification of Z-Series Scores

Z-Score went through further development. Z'-Score and Z"-Score models were added later.
Z-Score - US Public Manufacturing companies.
Z' Score - US Private Manufacturing.
Z" Score - US Non-Manufacturing and Foreign Firms



Z-Series Score Formula

The original Z-score formula is as follows:

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5, where
X1 = Working Capital / Total Assets. Measures liquid assets in relation to the size of the company.
X2 = Retained Earnings / Total Assets. Measures profitability that reflects the company's age and earning power.
X3 = Earnings Before Interest and Taxes / Total Assets. Measures operating efficiency apart from tax and leveraging factors. It recognizes operating earnings as being important to long-term viability.
X4 = Market Value of Equity / Book Value of Total Liabilities. Adds market dimension that can show up security price fluctuation as a possible red flag.
X5 = Sales / Total Assets. Standard measure for total asset turnover (varies greatly from industry to industry).


Z' = 0.717X1 + 0.847X2 + 3.107X3 + 0.420X4 + 0.998X5, where
X1 = Working Capital / Total Assets. Measures liquid assets in relation to the size of the company.
X2 = Retained Earnings / Total Assets. Measures profitability that reflects the company's age and earning power.
X3 = Earnings Before Interest and Taxes / Total Assets. Measures operating efficiency apart from tax and leveraging factors. It recognizes operating earnings as being important to long-term viability.
X4 = Book Value of Equity / Book Value of Total Liabilities. Adds market dimension that can show up security price fluctuation as a possible red flag.
X5 = Sales / Total Assets. Standard measure for total asset turnover (varies greatly from industry to industry).


Z" = 6.56X1 + 3.26X2 + 6.72X3 + 1.05X4 + 3.25, where
X1 = Working Capital / Total Assets. Measures liquid assets in relation to the size of the company.
X2 = Retained Earnings / Total Assets. Measures profitability that reflects the company's age and earning power.
X3 = Earnings Before Interest and Taxes / Total Assets. Measures operating efficiency apart from tax and leveraging factors. It recognizes operating earnings as being important to long-term viability.
X4 = Book Value of Equity / Book Value of Total Liabilities. Adds market dimension that can show up security price fluctuation as a possible red flag.



Z-Series Score Bands:

Z - US Public Manufacturing - Below 1.81 is distress zone, above 2.99 is safe zone
Z' - US Private Manufacturing - Below 1.23 is distress zone, above 2.9 is safe zone
Z" - US Non-Manufacturing and Foreign Firms - Below 1.1 is distress zone, and above 2.6 is safe zone (after discounting 3.25 from the score)

image026.jpg

NOTE: Net Working Capital (NWC), Sales, Retained Earnings (R/E), Book Value (BV) of Equities, Book Value (BV) of Liabilities, Market Value (MV) of Equities, Total Assets, Preferred Stock (P/S) figures are in millions.

Date Reported

Z-Score

Z"-Score

Applicable

Distress Zone

NWC

Sales

RE

BV Liabilities

MV Equities

BV Equities

Total Assets

Market Capital

P/S

Jun 30, 2019

1.5

3.1

Z-Score

RED ZONE

593.18

24,941.43

-6,331.64

24,722.14

38,617.99

7,150.46

31,872.6

38,617.99

0

Mar 31, 2019

1.28

2.47

Z-Score

RED ZONE

-1,564.98

22,593.98

-5,923.31

22,874.62

33,109

6,037.91

28,912.52

33,109

0

Dec 31, 2018

1.68

2.52

Z-Score

RED ZONE

-1,685.83

21,461.27

-5,317.83

23,426.01

50,867.83

6,313.6

29,739.61

50,867.83

0

Sep 30, 2018

1.64

2.2

Z-Score

RED ZONE

-1,854.83

17,523.64

-5,457.31

23,409.14

59,365.99

5,853.57

29,262.71

59,365.99

0

Jun 30, 2018

1.29

1.71

Z-Score

RED ZONE

-2,441.57

13,683.91

-5,768.83

22,642.89

55,045.98

5,267.11

27,910

55,045.98

0

Mar 31, 2018

1.48

1.89

Z-Score

RED ZONE

-2,266.44

12,471.23

-5,051.29

21,551.02

58,215.76

5,720.41

27,271.43

58,215.76

0

Sep 30, 2017

1.53

2.86

Z-Score

RED ZONE

599.79

10,755.13

-4,298.96

21,929.41

54,639.13

6,177.66

28,107.07

54,639.13

0

Jun 30, 2017

1.86

2.91

Z-Score

RED ZONE

-186.91

10,068.89

-3,679.58

19,461.59

57,609.45

6,582.11

26,043.71

57,609.45

0

Mar 31, 2017

2.06

3.17

Z-Score

RED ZONE

782.45

8,549.35

-3,343.19

18,892.64

61,970.27

6,161.09

25,053.73

61,970.27

0

Dec 31, 2016

1.38

3.14

Z-Score

RED ZONE

432.79

7,000.13

-2,875.9

16,750.17

36,900.19

5,913.91

22,664.08

36,891.41

8,784,000

Sep 30, 2016

1.86

3

Z-Score

RED ZONE

1,090.02

5,929.88

-2,875.9

9,911.91

29,383.68

2,680.49

12,592.4

29,383.68

0

Jun 30, 2016

2.02

3

Z-Score

RED ZONE

1,437.3

4,568.23

-2,897.78

9,348.66

32,561.82

2,520.29

11,868.95

32,561.82

0

Mar 31, 2016

1.91

1.86

Z-Score

RED ZONE

51.84

4,253.19

-2,604.59

8,221.34

29,392.54

970.37

9,191.7

29,392.54

0

 

Tesla Altman Z-Score Calculation (https://www.gurufocus.com/term/zscore/TSLA/Altman%252BZ-Score/Tesla%2BInc)

Altman Z-Score model is an accurate forecaster of failure up to two years prior to distress. It can be considered the assessment of the distress of industrial corporations.

Tesla's Altman Z-Score for today is calculated with this formula:

Z

=

1.2

*

X1

+

1.4

*

X2

+

3.3

*

X3

+

0.6

*

X4

+

1.0

*

X5

=

1.2

*

0.0804

+

1.4

*

-0.1573

+

3.3

*

0.0331

+

0.6

*

14.6109

+

1.0

*

0.6741

=

9.43

* All numbers are in millions except for per share data and ratio. All numbers are in their local exchange's currency. GuruFocus does not calculate Altman Z-Score when X4 or X5 value is 0.

Trailing Twelve Months (TTM) ended in Jun. 2020:

Total Assets was $38,135 Mil.

Total Current Assets was $15,336 Mil.

Total Current Liabilities was $12,270 Mil.

Retained Earnings was $-6,000 Mil.

Pre-Tax Income was 150 + 70 + 174 + 176 = $570 Mil.

Interest Expense was -170 + -169 + -170 + -185 = $-694 Mil.

Revenue was 6036 + 5985 + 7384 + 6303 = $25,708 Mil.

Market Cap (Today) was $400,498 Mil.

Total Liabilities was $27,411 Mil.

 

X1

=

Working Capital

/

Total Assets

=

(Total Current Assets - Total Current Liabilities)

/

Total Assets

=

(15336 - 12270)

/

38135

=

0.0804

X2

=

Retained Earnings

/

Total Assets

=

-6000

/

38135

=

-0.1573

 

X3

=

Earnings Before Interest and Taxes

/

Total Assets

=

(Pre-Tax Income - Interest Expense)

/

Total Assets

=

(570 - -694)

/

38135

=

0.0331

X4

=

Market Value Equity

/

Book Value of Total Liabilities

=

Market Cap

/

Total Liabilities

=

400498.053

/

27411

=

14.6109

 

X5

=

Revenue

/

Total Assets

=

25708

/

38135

=

0.6741

The zones of discrimination were as such:

Distress Zones - 1.81 < Grey Zones < 2.99 - Safe Zones

Tesla has a Altman Z-Score of 9.43 indicating it is in Safe Zones.

Study by Altman found that companies that are in Distress Zone have more than 80% of chances of bankruptcy in two years.


Tesla  (NAS:TSLA) Altman Z-Score Explanation

X1: The Working Capital/Total Assets (WC/TA) ratio is a measure of the net liquid assets of the firm relative to the total capitalization. Working capital is defined as the difference between current assets and current liabilities. Ordinarily, a firm experiencing consistent operating losses will have shrinking current assets in relation to total assets. Altman found this one proved to be the most valuable liquidity ratio comparing with the current ratio and the quick ratio. This is however the least significant of the five factors.

X2: Retained Earnings/Total Assets: the RE/TA ratio measures the leverage of a firm. Retained earnings is the account which reports the total amount of reinvested earnings and/or losses of a firm over its entire life. Those firms with high RE, relative to TA, have financed their assets through retention of profits and have not utilized as much debt.

X3, Earnings Before Interest and Taxes/Total Assets (EBIT/TA): This ratio is a measure of the true productivity of the firm's assets, independent of any tax or leverage factors. Since a firm's ultimate existence is based on the earning power of its assets, this ratio appears to be particularly appropriate for studies dealing with corporate failure. This ratio continually outperforms other profitability measures, including cash flow.

X4, Market Value of Equity/Book Value of Total Liabilities (MVE/TL): The measure shows how much the firm's assets can decline in value (measured by market value of equity plus debt) before the liabilities exceed the assets and the firm becomes insolvent.

X5, Revenue/Total Assets (S/TA): The capital-turnover ratio is a standard financial ratio illustrating the sales generating ability of the firm's assets.

 

Homework of chapter 7 part I: (Due with the second mid term exam)

1.      Who are the top three rating agencies? How do rating agencies make money? What do the rating agencies look for?

2.      What is Z score? Find the Z scores of Wal-Mart, Apple, and Delta Airline and draw a conclusion.  For example, you can find Delta’s z score at https://www.gurufocus.com/term/zscore/DAL/Altman-Z-Score/Delta-Air-Lines-Inc

3.      From Tesla’s z score table, what can you conclude? Do you think that Tesla might be bankrupt in the near future based on its z score? Why or why not? Note that the z score of Tesla is 9.43 as of 9/25/2020.

 

From https://www.gurufocus.com/term/zscore/TSLA/Altman%252BZ-Score/Tesla%2BInc

 

NAS:TSLA' s Altman Z-Score Range Over the Past 10 Years
Min: -3.22   Med: 1.93   Max: 9.22
Current: 9.22

 

Competitive Comparison Data

Ticker

Company

Market Cap (M)

Altman Z-Score

TSLA

Tesla Inc

$ 400,498.05

9.22

TSE:7203

Toyota Motor Corp

$ 183,763.34

1.52

XTER:VOW3

Volkswagen AG

$ 85,640.48

0.94

XTER:NSU

Audi AG

$ 81,294.04

2.69

XTER:DAI

Daimler AG

$ 57,396.86

0.97

XTER:BMW

Bayerische Motoren Werke AG

$ 46,934.21

0.71

MIL:RACE

Ferrari NV

$ 45,636.51

6.89

HKSE:01211

BYD Co Ltd

$ 45,208.52

2.27

GM

General Motors Co

$ 42,346.15

0.85

TSE:7267

Honda Motor Co Ltd

$ 40,492.55

1.59

 

 

 

$1 Trillion of Corporate Bonds Today, Downgrades Tomorrow

The fastest-ever borrowing binge was necessary but will inevitably weigh down credit ratings.

https://www.bloomberg.com/opinion/articles/2020-05-28/-1-trillion-of-corporate-bonds-today-downgrades-tomorrow

 

By Brian Chappatta

May 28, 2020, 12:00 PM EDT

 

The amount of new debt issued this year in the U.S. investment-grade corporate bond market will reach $1 trillion today, by far the fastest pace in history. 

The implications of that milestone depend on how you look at it.

For businesses that had been ravaged by the coronavirus pandemic and the ensuing nationwide lockdowns, access to capital markets was a lifeline to get through the worst of the economic collapse. Sure, Carnival Corp. had to offer interest rates like a junk-rated borrower and Boeing Co. needed to include a so-called coupon step-up provision to offset jitters that it could lose its investment grades. But, in the words of Federal Reserve Chair Jerome Powell, these deals avoided turning “liquidity problems into solvency problems” for brand-name American companies.

 

It’s worth remembering that until the Fed stepped in with extraordinary support for credit markets, averting widespread failures was far from guaranteed. Investors pulled a staggering $35.6 billion and $38 billion from investment-grade funds in the weeks ended March 18 and March 25, respectively. Before 2020, the previous record was $5.1 billion of outflows. I wrote on March 19 that bond markets were veering into a vicious cycle that could get ugly in a hurry — four days later, the Fed announced what would end up becoming a $750 billion backstop for corporate America.

Now, the Fed hasn’t actually had to buy any individual bonds yet, a fact that Powell seems proud to share. “We may have to be lending money to those companies, but even better, they can borrow themselves now, and a lot of that has been happening and that’s a really good thing,” he said during May 19 testimony before the Senate Banking Committee.

image032.jpg

 

Most people would probably agree with that assessment, at least for the immediate future as the country grapples with restarting the worlds largest economy. But what about the longer-term view?

 

Here, the rampant borrowing paints a more sobering picture. As of late April, 1,287 issuers worldwide rated between AAA and B- by S&P Global Ratings were considered at risk of a potential downgrade, up from 860 in March and 649 in February. That surpasses the previous all-time high set in 2009. Generally, we expect heavy credit erosion in coming months as issuers, especially those in the lower-rated spectrum come under heavy fire from poor earnings, continued difficulties in managing cost structures, and market volatility creating limited funding opportunities, said Sudeep Kesh, head of S&Ps credit markets research.

 

That’s bad enough, but doesn’t even strike at the heart of the issue. Last year was supposed to be the beginning of a broad “debt diet” among companies that borrowed huge sums to finance mergers and acquisitions during the longest expansion in U.S. history. That didn’t end up taking place on a wide scale. Even a success story like AT&T Inc., which made headway in trimming its debt stack, still found itself back in the bond market recently, borrowing $12.5 billion on May 21 in what was the biggest deal since Boeing’s $25 billion blockbuster offering.

When it comes to companies directly impacted by the coronavirus pandemic or structural changes to their industries, the “big three” of S&P, Moody’s Investors Service and Fitch Ratings haven’t shied away from taking action. Ford Motor Co., Kraft Heinz Co., Macy’s Inc. and Occidental Petroleum Corp. are just a few of the “fallen angels” that lost their investment grades earlier this year.

The rating companies havent been quite as keen to react to high leverage metrics. I frequently refer back to this feature from Bloomberg Newss Molly Smith and Christopher Cannon, which found that of the 50 biggest corporate acquisitions in the five years through October 2018, more than half of the acquiring companies increased their leverage to a level that would seemingly merit a junk rating but remained investment grade on the assumption that theyd take that leverage down in the coming years. 

 

image031.jpg

Those expectations seemed ambitious in 2018, when the economy was seemingly invincible. Now, no one can truly expect companies to focus on right-sizing their debt. Corporate leaders are rightfully eager to raise cash to get to the other side of the pandemic, especially with all-in yields not far off from record lows. The vast majority of the $1 trillion in borrowing so far this year was by no means imprudent.

In the years ahead, however, the overhang from this issuance spree will inevitably weigh down credit ratings. A company with more debt presents a greater risk of missed interest payments than if it had fewer fixed obligations. Fortunately, for much of the previous expansion, firms had no issue finding investors willing to buy their long-term securities. That practice of rolling over debt and extending maturities might very well be the norm in the months and years ahead, too. 

Still, if the first five months of 2020 are any indication, investment-grade bondholders will have to get comfortable with even more bloated balance sheets and the prospect of further credit downgrades. For better or worse, with the confidence that the Fed has their back, that seems like a risk investors are willing to take.

For discussion:

·         Why do firms borrow so much money?

·         The more debt the firm has, the riskier the firm will be, and the lower its debt will be rated. And it will be more likely that the bond will be down-graded, resulting a selloff of the bond. Right?

 

 

 

Years of reform failed to alter rating agency business models blamed for crisis

·         https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/years-of-reform-failed-to-alter-rating-agency-business-models-blamed-for-crisis-45338275

·          

·                   Author Zach Fox Sophia Furber

 

After inflated ratings played a critical role in the 2008 financial crisis, policymakers across the world called for more competition in credit ratings and changes to agencies' business models. Ten years after the crisis, rating agencies make money the same way, and the top three companies are as dominant as ever.

The U.S. government's 2011 post-mortem report on the crisis called the rating agencies' actions "essential cogs in the wheel of financial destruction." When European regulators unveiled a suite of rules for ratings agencies, they cited the role of ratings in both the 2008 crisis and the European sovereign debt crisis. Policymakers from both continents argued that the agencies' very business models were central to the failures, reasoning that since issuers paid for ratings of their own securities, agencies "felt pressured" to give high ratings even though emails showed ratings analysts knew the housing market was a "house of cards."

While rating agencies stress they have taken steps to improve methodologies and transparency, their business models remain effectively unchanged, and the largest rating agencies retain dominant market share. Data from the U.S. Securities and Exchange Commission show the "big three" rating agencies — S&P Global Inc. unit S&P Global Ratings, Moody's Corp. and Fitch Ratings — accounted for 94.4% of all rating agency revenue in 2016.

"It seems strange to think that despite their role in the financial crisis and the billions of dollars of losses suffered by investors and taxpayers, the business model of rating agencies remains unchanged," Dominic Lindely, director of policy at London-based New City Agenda, a financial services think tank focused on improving social value in the financial services industry, wrote in an email.

 

Efforts to change the business model

 

In the U.S., the Dodd-Frank Act sought to mitigate the conflict of interest in the agencies' business models by encouraging unsolicited ratings — ratings from agencies that were not paid by the security's issuer. There were two significant mechanisms: the Franken Amendment and a disclosure website.

Dodd-Frank directed the SEC to study business models for "nationally recognized" rating agencies — a crucial certification that is required for financial firms investing in securities. If the SEC could not recommend an alternative business model, the Franken Amendment dictated the establishment of a board that randomly assigns securities to rating agencies. The SEC produced a study of various business models and held a roundtable discussion on the topic in 2013, but it did not recommend a specific business model and declined to establish a random-assignment board. The issue has received no political attention in recent years, and the driving force behind the amendment, Sen. Al Franken, D-Minn., has resigned following a sexual harassment scandal.

"We're doing new financial regulatory reforms right now. How about looking at ratings agencies again? But there doesn't seem to be any appetite for that," said Marc Joffe, a senior policy analyst for libertarian think tank Reason Foundation who recently authored a report calling rating agencies the "weakest link" in the financial system.

The law also required greater transparency from rating agencies, mandating the disclosure of the methodology behind ratings as well as specific data used to determine the rating. An SEC rule forces rating agencies to disclose data on password-protected websites accessible by competitors. The idea was that other agencies would access the data and issue an unsolicited rating, serving as a check against any ratings that might be overly accommodating to issuers. The websites are operational, but industry observers say they are rarely used and unsolicited ratings remain non-existent.

"It creates a lot of bother for everyone in structured finance, but it never created its intended effect of unsolicited ratings," said Mark Adelson, a former chief credit officer in charge of ratings methodologies for Standard & Poor's Ratings Services who is now editor of The Journal of Structured Finance.

In Europe, regulators increased oversight of rating agencies and forced methodology changes. The European Commission also issued rules meant to decrease investors' reliance on ratings. But the top three rating agencies maintain a dominant presence in Europe, too, with a 93.0% market share as of December 2017.

Without a market for unsolicited ratings, rating agencies continue to use the issuer-paid model. Some ratings agencies have tried to focus on payments from subscribers rather than issuers, but success has proven elusive. Kroll Bond Rating Agency launched in 2009 with the goal of a subscription-based model but began allowing issuer-paid ratings due to market pressure. Egan-Jones Ratings Company has also promoted its subscription-based approach, but its market share remains tiny. Media representatives for both Kroll and Egan-Jones did not respond to requests for comment.

 

What has changed

 

While regulations have not spurred a market for unsolicited ratings, there have been changes. The law led to several SEC rules, which have required ratings agencies to be more transparent in how they determine ratings. Other rules require agencies standardize so that a rating of "AAA" on a structured finance product matches a rating of "AAA" on corporate finance. The 2011 governmental report on the crisis noted that 83% of all mortgage securities rated AAA in 2006 were ultimately downgraded. In 2009, S&P Global Ratings downgraded just 8.6% of AAA-rated corporates to AA ratings.

"We have strengthened our independence from potential issuer influence, improved our methodologies, increased our monitoring of global credit risks, and have enhanced our regulatory compliance and analytical quality," wrote John Piecuch, a spokesman for S&P Global Ratings, in an email. Media representatives from Moody's and Fitch declined to comment.

The changes are evident: Documents published after the crisis show more detail in how the agencies calculate risk and include examples of hypothetical companies or issuance.

image036.jpg

" Comparability and transparency were the watchwords that everything else was built off of," said Adelson, who was tasked with many of the post-crisis changes at S&P.

For rating agency critics, however, the changes are insufficient. Bill Harrington, a former credit officer at Moody's, said ratings agencies continue to operate with impunity, issuing substandard ratings, enabled by a compliant SEC that suspended a Dodd-Frank provision that would have increased legal liability for inaccurate ratings.

"The SEC will not go near the content of ratings or methodologies. It picks and chooses which rules to enforce and which rules not to enforce," Harrington, who is now a senior fellow at the nonprofit Croatan Institute said. "It leaves ratings agencies unaccountable."

Whether the post-crisis changes have yielded ratings that are more robust will not be known until the ratings are tested by a credit downturn. Adelson said ratings agencies clearly have invested heavily in updating methodologies, changes that have generally improved the transparency and consistency of ratings.

Consistency for structured finance ratings has been a goal ever since the crisis, which was driven, in part, by highly rated collateralized debt obligations that ultimately collapsed. In 2008, Moody's downgraded 91% of single-family CDOs, but it only cut 37% of residential mortgage-backed securities. Ann Rutledge, CEO of CreditSpectrum, an unlicensed credit rating agency, said the changes instituted by Dodd-Frank failed to address those core issues in structured finance.

"I think the whole thrust of Dodd-Frank was legal and moral," she said. "And the problems leading to the crisis were technical."

S&P Global Ratings and S&P Global Market Intelligence are both owned by S&P Global Inc.

 

For discussion:

 

1.      Transparency is suggested. If only z score is used to rate securities, transparency should not be an issue. Right?

2.      So the model used to rate securities should be more complicated than a simple z score. So do you think that the rating agencies should reveal their methodologies for rating bonds?

3.      Do you trust the ratings given by the three rating agencies?

 

Part III: Yield curve (or Term structure)

·        What is yield curve? ( http://www.yieldcurve.com/MktYCgraph.htm)

Market watch on Wall Street Journal has daily yield curve and interest rate information.

http://www.marketwatch.com/tools/pftools/

 

 

For Discussion

·        Why do we need yield curve?

 

·        What can yield curve tell us?

 

 

U.S. Treasury Yield Curve

https://www.gurufocus.com/yield_curve.php

 

As of 10/05/2020

1-month yield

0.09%

1-year yield

0.12%

2-year yield

0.14%

10-year yield

0.78%

30-year yield

1.57%

 

image057.jpg

 

For discussion:

·        Compare the yield curves in the three years. What do you conclude?

·        2019 Oct’s yield curve is inverted. What did it suggest? What Is An Inverted Yield Curve And How Does It Affect The Stock Market? | NBC News Now (video)

·        2020 Oct’s yield curve is steeply upward sloping. What does it imply?

·        Do you believe the economic forecast based on yield curve? (refer to the following)

 

 

Summary of Yield Curve Shapes and Explanations

 

Normal Yield Curve
When bond investors expect the economy to hum along at normal rates of growth without significant changes in inflation rates or available capital, the yield curve slopes gently upward. In the absence of economic disruptions, investors who risk their money for longer periods expect to get a bigger reward — in the form of higher interest — than those who risk their money for shorter time periods. Thus, as maturities lengthen, interest rates get progressively higher and the curve goes up.

image013.jpg

 

Steep Curve – Economy is improving
Typically the yield on 30-year Treasury bonds is three percentage points above the yield on three-month Treasury bills. When it gets wider than that — and the slope of the yield curve increases sharply — long-term bond holders are sending a message that they think the economy will improve quickly in the future.

image014.jpg

 

Inverted Curve – Recession is coming
At first glance an inverted yield curve seems like a paradox. Why would long-term investors settle for lower yields while short-term investors take so much less risk? The answer is that long-term investors will settle for lower yields now if they think rates — and the economy — are going even lower in the future. They're betting that this is their last chance to lock in rates before the bottom falls out.

image015.jpg

 


Flat or Humped Curve

To become inverted, the yield curve must pass through a period where long-term yields are the same as short-term rates. When that happens the shape will appear to be flat or, more commonly, a little raised in the middle.

Unfortunately, not all flat or humped curves turn into fully inverted curves. Otherwise we'd all get rich plunking our savings down on 30-year bonds the second we saw their yields start falling toward short-term levels.

On the other hand, you shouldn't discount a flat or humped curve just because it doesn't guarantee a coming recession. The odds are still pretty good that economic slowdown and lower interest rates will follow a period of flattening yields.

image016.jpg

 

 

What Is An Inverted Yield Curve And How Does It Affect The Stock Market? | NBC News Now (video)

 

 

5 things investors need to know about an inverted yield curve

Published: Aug 28, 2019 9:43 a.m. ET

By

WILLIAM WATTS

 

  

The 10-year yield fell below the 2-year yield for the first time since June 2007

https://ei.marketwatch.com/Multimedia/2019/08/14/Photos/ZH/MW-HP402_yield__20190814101008_ZH.jpg?uuid=38ccfe96-be9d-11e9-b975-9c8e992d421e

The main measure of the yield curve briefly deepened its inversion on Tuesday — with the yield on the 10-year Treasury note extending its drop below the yield on the 2-year note — underlining investor worries over a potential recession.

But while inversions are seen as a reliable indicator of an economic downturn, investors may be pushing the panic button prematurely. Here’s a look at what happened and what it might mean for financial markets.

What’s the yield curve?

The yield curve is a line plotting out yields across maturities. Typically, it slopes upward, with investors demanding more compensation to hold a note or bond for a longer period given the risk of inflation and other uncertainties.

An inverted curve can be a source of concern for a variety of reasons: short-term rates could be running high because overly tight monetary policy is slowing the economy, or it could be that investor worries about future economic growth are stoking demand for safe, long-term Treasurys, pushing down long-term rates, note economists at the San Francisco Fed, who have led research into the relationship between the curve and the economy.

They noted in an August 2018 research paper that, historically, the causation “may have well gone both ways” and that “great caution is therefore warranted in interpreting the predictive evidence.”

 

What just happened?

The yield curve has been flattening for some time. A global bond rally in the wake of rising trade tensions pulled down yields for long-term bonds. The 10-year Treasury note yield TMUBMUSD10Y, -1.05% fell as low as 1.453% on Wednesday, trading around 4 basis points below the yield on the 2-year note peerTMUBMUSD02Y, -0.25%.

The inversion on this widely-watched measure of the yield curve’s slope had already taken place two weeks ago, when signs of economic weakness across the globe drew investors into haven

 

Why does it matter?

The 2-year/10-year version of the yield curve has preceded each of the past seven recessions, including the most recent slowdown between 2007 and 2009.

Other yield curve measures have already inverted, including the widely-watched 3-month/10-year spread used by the Federal Reserve to gauge recession probabilities.

 

Is recession imminent?

A recession isn’t a certainty. Some economists have argued that the aftermath of quantitative easing measures that saw global central banks snap up government bonds and drive down longer term yields may have robbed inversions of their reliability as a predictor. According to this school of thought, negative bond yields in Europe and Japan have forced yield-starved investors to the U.S., artificially depressing long-term Treasury yields.

 

Some Fed policy makers, including New York Fed President John Williams, have also periodically questioned the overwhelming importance placed by market participants on the yield curve, seeing it as only one measure among many that could point to economic distress.

Others say an inversion of the yield curve reflects when the bond-market is expecting the U.S. central bank to set off on an extended easing cycle. This pent-up anticipation drives long-term bond yields below their short-term peers. But if the Fed cuts rates in a speedy fashion and successfully prevents an economic downturn, the yield curve’s inversion this time around may turn out to be a false positive.

 

And even if the yield curve does point to a future recession, investors might not want to panic immediately. From 1956, past recessions have started on average around 15 months after an inversion of the 2-year/10-year spread occurred, according to Bank of America Merrill Lynch.

 

Are market worries overdone?

Some investors argued that until other recession indicators, such as the unemployment rate, start blinking red, it’s probably premature to press the panic button.

“It’s a recession indicator among many others, though the yield curve may be flashing red, others are not,” said Adrian Helfert, director of multi-asset portfolios at Westwood Holdings Group, in an interview with MarketWatch.

 

 

Homework chapter 7 part II (due with the second mid-term exam):

1.      Based on yield curve inversion: What is it, why it matters and what to do now?”, please answer the following questions.

·         What does inverted yield curve usually indicate to the market? Why?

·         What are the causes of the current inverted yield curve this time? 

·         What is the advice of the author based on this article?

 

2.       Draw the yield curve of any day in October, 2020. Describe the shape of the yield curve. And what economic forecast is derivable from it?

Yield Curve Inversion: What Is It, Why It Matters and What to Do Now

The yield curve has inverted, again but it's not time to sell everything ... yet

By Luke Lango, InvestorPlace Markets Analyst 

Amid the Dow Jones Industrial Average dropping 2,000 points in two days (its biggest two day drop, ever) on concerns that the coronavirus is rapidly expanding outside of China and turning into a pandemic, you probably missed something that would otherwise be dominating financial headlines everywhere. That is, in mid-February, Wall Street’s favorite recession indicator — a yield curve inversion — appeared, again, for the second time in seven months.

A yield curve inversion happens when long-term interest rates fall below short-term interest rates, indicative that investor demand for long-term fixed income instruments is unusually high and expectations for near-term economic growth are unusually low.

It’s a scary sign. A yield curve inversion has successfully predicted every U.S. recession since 1930.

So, with the yield curve inverted, the coronavirus gradually turning into a global pandemic, and the bull market in its eleventh year, is it time to call it one heck of a run, and take profits off the table?

I don’t think so. Not yet, at least.

But, in order to understand why, let’s take a step back and answer some basic questions. What exactly is a yield curve inversion? Why does it predict recessions? What normally happens after an inversion? What’s different this time around?

Let’s answer all those questions, and more, in this guide to understanding a yield curve inversion and what it means for your money today.

What Is a Yield Curve Inversion?

The yield curve inverts when long-term interest rates fall below short-term ones.

That is an abnormal circumstance in financial markets. Normally, short-term interest rates are below long-term interest rates, indicative of the fact that investors require more return for keeping their money tied up for longer.

But, when investors expect that a slowdown is coming, they don’t care about getting more return for keeping their money tied up. They just want to lock in yield. So, they pile into instruments with the best yields, which are long-term fixed income instruments. That flight into safe-haven assets pushes long-term bond prices up.

When prices go up, yields go down, and this causes a yield curve inversion.

Why Does It Predict Recessions?

A yield curve inversion is considered a reliable recession indicator on Wall Street for two reasons.

First, it’s the bond market telling you something. Many people forget this, but the bond market is actually bigger than the stock market. The global capitalization of the stock market is about $85 trillion. The global bond market measures in around $100 trillion. When $100 trillion is trying to tell you something, you should listen.

A yield curve inversion is that $100 trillion market telling you that a slowdown is coming, and that it’s time to lock in yield wherever you can find it.

Second, the yield curve has a history of getting it right. Since 1930, a yield curve inversion has successfully predicted every U.S. recession. The timing hasn’t always been perfect (more on that later). But, it has never failed to predict a major slowdown.

What Usually Happens After an Inversion?

While yield curve inversions do tend to predict recessions, they are also notoriously premature.

Both my research and research from LPL Research show that yield curve inversions are actually a near-term bullish, medium-term bearish sign for stocks.

Specifically, a full yield curve inversion — typically defined by the 10-Year Treasury yield falling below the 2-Year Treasury yield — has only happened a handful of times over the past 50 years. Yes, each inversion successfully predicted a recession. But, on average, the stock market didn’t peak until about 20 months after the inversion happened. During those 20 months, stocks tended to post outstanding returns, with average returns north of 25%.

So, yield curves do predict recessions, but they tend to be about 20 months early, and history says you don’t want to sit out those 20 months.

Also of note, the big thing to watch is the 2-Year Treasury yield. Immediately prior to each stock market peak in the past thirty years, the yield curve actually normalized into the peak, driven by a plunge in the 2-Year Treasury yield on bond market expectations that rates were going to get cut multiple times to help thwart a forthcoming slowdown.

What’s Going to Happen Now?

The yield curve inversion is something to note. But, it’s nothing to freak out about. Yet.

We are only seven months from the 10-2 yield curve inversion in August 2019, and in the middle of the February inversion. That doesn’t line up with how these things work historically. You don’t get market peaks when everyone is freaking out about a yield curve inversion. You get market peaks when everyone forgets about the yield curve inversion, and animal spirits take over. Normally, it takes about 20 months for that to happen. That timing pegs the next market peak in the second quarter of 2021.

At the same time, the 2-Year yield is falling, but not plunging like it has before prior recessions. Until that plunges on expectations for huge rate cuts, there really isn’t much cause for concern here.

In other words, the yield curve is flashing warning signs right now — but no stop signs.

Fundamentally, I agree with the yield curve. The economy and the market have some warning signs, such as the coronavirus outbreak and slowing global growth. But, the core fundamentals remain pretty solid. Labor markets are healthy. Spending conditions are favorable. Businesses are growing. Central banks are injecting liquidity.

The fundamentals are still pretty good. So long as that remains true, this bull market likely won’t die.

Bottom Line

Yield curve inversions are scary. The February inversion is no different. It’s scary.

But, it’s warning sign, not a stop sign. Be cognizant of the building risks in financial and equity markets. But don’t ditch stocks. This bull market isn’t over yet.

Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by TipRanks, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

 

Chapter 5 Diversification  Part I Diversification

 

ppt

 

“Members of a Yale class entering their prime giving years had decided to set up a private fund, manage the money themselves, and give it to the University 25 years later. The worrisome part for Yale was that it would have no control over the fund, which was going to be invested in high-risk securities. What if all the money was blown by these “amateurs"? And what if the scheme siphoned off other potential donations?

Happily, everything turned out for the best. Despite Yale’s initial efforts to discourage the Class of 1954 from its plan, the class persisted. And last October, its leaders announced that their original collective investment of $380,000 had grown to $70 million, earning unalloyed gratitude from the University and the right to name two new Science Hill buildings after their class.” ----- What is your opinion? Apple is one of the stocks in their portfolio. So shall you pick stocks individually or buy S&P500?

Shall you diversify or not? Let’s compare AAPL with S&P500.

Stock  returns from 1995-2015 - Apple and S&P 500

image017.jpg

image018.jpg

image019.jpg

 

Regress Apple’s Return on S&P500’s

image020.jpg

Apple and S&P500’s Stand Deviation Comparison

image021.jpg

Questions for class discussion:

·         Which one is better, the S&P500 or Apple? In the past? About the future?

·         Which one is riskier and which one’s return is higher?

·         Are you tempted to invest in APPLE or SP500?

·         How to find the next Apple?

·         How much is the weight of Apple in S&P500? For example, you have a total of $1,000 to invest in SP500, how much you have invested in apple?

·         How are the weights in the following table calculated? (please refer to the following paper)

 

 
S&P 500 index

 

The table below shows the historical total market capitalization of the 500 largest public U.S. companies. The current (12/31/2019) market value of the top 500 companies is $28,125,589.1 million. The total value of the U.S. stock market as a whole is $37,689,255.8 million.

U.S. Top 500 Companies – Total Market Cap (USD, M)

Date

Top 500 Total Market Value (USD, M)

Total U.S. Stock Market Values (USD, M)

12/31/2019

28,125,589.1

37,689,255.8

12/31/2018

22,065,655.2

30,102,771.2

12/31/2017

23,938,148.8

31,774,585.4

12/31/2016

20,222,191.7

27,362,567.7

12/31/2015

18,774,069.5

25,076,923.7

12/31/2014

19,331,041.0

26,338,838.9

12/31/2013

17,482,338.6

24,041,484.6

12/31/2012

13,499,871.5

18,673,959.2

12/31/2011

11,982,408.4

15,645,563.9

 

 

 
Components of the S&P 500  https://www.slickcharts.com/sp500

 

S&P 500 Companies by Weight

The S&P 500 component weights are listed from largest to smallest. Data for each company in the list is updated after each trading day. The S&P 500 index consists of most but not all of the largest companies in the United States. The S&P market cap is 70 to 80% of the total US stock market capitalization. It is a commonly used benchmark for stock portfolio performance in America and abroad. Beating the performance of the S&P with less risk is the goal of nearly every portfolio manager, hedge fund and private investor.

Components of the S&P 500

#

Company

Symbol

Weight

      Price

Chg

% Chg

1

Apple Inc.

AAPL

6.528728

https://www.slickcharts.com/img/up.gif   115.37

2.21

(1.95%)

2

Microsoft Corporation

MSFT

5.592237

https://www.slickcharts.com/img/up.gif   209.80

3.89

(1.89%)

3

Amazon.com Inc.

AMZN

4.736621

https://www.slickcharts.com/img/up.gif   3,199.00

99.04

(3.19%)

4

Facebook Inc. Class A

FB

2.231831

https://www.slickcharts.com/img/down.gif   258.00

-0.66

(-0.26%)

5

Alphabet Inc. Class A

GOOGL

1.564675

https://www.slickcharts.com/img/up.gif   1,461.00

9.98

(0.69%)

6

Alphabet Inc. Class C

GOOG

1.531444

https://www.slickcharts.com/img/up.gif   1,460.29

6.85

(0.47%)

7

Berkshire Hathaway Inc. Class B

BRK.B

1.49574

https://www.slickcharts.com/img/up.gif   213.29

3.03

(1.44%)

8

Johnson & Johnson

JNJ

1.381958

https://www.slickcharts.com/img/up.gif   147.88

1.62

(1.11%)

9

Procter & Gamble Company

PG

1.247373

https://www.slickcharts.com/img/up.gif   140.70

1.09

(0.78%)

10

NVIDIA Corporation

NVDA

1.217107

https://www.slickcharts.com/img/up.gif   560.80

11.34

(2.06%)

11

Visa Inc. Class A

V

1.212866

https://www.slickcharts.com/img/up.gif   202.47

2.02

(1.01%)

12

UnitedHealth Group Incorporated

UNH

1.072804

https://www.slickcharts.com/img/up.gif   323.17

8.72

(2.77%)

13

JPMorgan Chase & Co.

JPM

1.072536

https://www.slickcharts.com/img/up.gif   99.73

1.71

(1.74%)

14

Mastercard Incorporated Class A

MA

1.069716

https://www.slickcharts.com/img/up.gif   343.90

6.47

(1.92%)

15

Home Depot Inc.

HD

1.068046

https://www.slickcharts.com/img/up.gif   282.79

6.32

(2.29%)

16

Verizon Communications Inc.

VZ

0.8834

https://www.slickcharts.com/img/up.gif   59.61

0.15

(0.25%)

17

Adobe Inc.

ADBE

0.824925

https://www.slickcharts.com/img/up.gif   494.00

15.02

(3.14%)

18

salesforce.com inc.

CRM

0.817264

https://www.slickcharts.com/img/up.gif   259.98

9.84

(3.93%)

19

PayPal Holdings Inc

PYPL

0.807395

https://www.slickcharts.com/img/up.gif   194.86

3.20

(1.67%)

20

Netflix Inc.

NFLX

0.800637

https://www.slickcharts.com/img/up.gif   535.39

29.52

(5.84%)

21

Walt Disney Company

DIS

0.784601

https://www.slickcharts.com/img/up.gif   122.91

1.98

(1.64%)

22

Intel Corporation

INTC

0.783188

https://www.slickcharts.com/img/up.gif   52.72

1.35

(2.63%)

23

AT&T Inc.

T

0.734436

https://www.slickcharts.com/img/up.gif   28.80

0.09

(0.31%)

24

Comcast Corporation Class A

CMCSA

0.7285

https://www.slickcharts.com/img/up.gif   44.90

0.39

(0.86%)

25

Merck & Co. Inc.

MRK

0.722793

https://www.slickcharts.com/img/up.gif   80.04

0.41

(0.51%)

 

 

 

Historical data about the component of S&P500

Ticker

Company Name

6/30/2019

12/31/2018

12/31/2017

12/31/2016

12/31/2015

12/31/2014

MSFT

Microsoft Corp.

4.20%

3.73%

2.89%

2.51%

2.48%

2.10%

AAPL

Apple Inc.

3.54%

3.38%

3.81%

3.21%

3.28%

3.55%

AMZN

Amazon.com Inc.

3.20%

2.93%

2.05%

1.54%

1.45%

0.65%

FB

Facebook Inc.

1.90%

1.50%

1.85%

1.40%

1.33%

0.72%

BRK.B

Berkshire Hathaway Inc

1.69%

1.89%

1.67%

1.61%

1.38%

1.51%

JNJ

Johnson & Johnson

1.51%

1.65%

1.65%

1.63%

1.59%

1.61%

GOOG

Alphabet Inc. Class C

1.36%

1.52%

1.39%

1.19%

1.26%

0.85%

GOOGL

Alphabet Inc. Class A

1.33%

1.49%

1.38%

1.22%

1.27%

0.84%

XOM

Exxon Mobil Corp.

1.33%

1.37%

1.55%

1.94%

1.81%

2.16%

JPM

JPMorgan Chase & Co.

1.48%

1.54%

1.63%

1.60%

1.36%

1.29%

V

Visa Inc.

1.23%

1.10%

0.91%

0.76%

0.84%

0.56%

PG

Procter & Gamble Co

1.13%

1.09%

1.03%

1.17%

1.21%

1.36%

BAC

Bank of America Corp.

1.05%

1.07%

1.26%

1.16%

0.98%

1.04%

VZ

Verizon Communications Inc

0.97%

1.11%

0.95%

1.13%

1.05%

1.07%

INTC

Intel Corp.

0.88%

1.02%

0.95%

0.89%

0.91%

0.95%

CSCO

Cisco Systems Inc

0.96%

0.93%

0.83%

0.79%

0.77%

0.78%

UNH

UnitedHealth Group Inc

0.95%

1.14%

0.94%

0.79%

0.63%

0.53%

PFE

Pfizer Inc.

0.98%

1.20%

0.95%

1.02%

1.11%

1.08%

CVX

Chevron Corp.

0.97%

0.99%

1.04%

1.15%

0.95%

1.17%

T

AT&T Inc.

1.00%

0.99%

1.05%

1.36%

1.18%

0.96%

HD

Home Depot Inc

0.94%

0.92%

0.97%

0.85%

0.94%

0.76%

MRK

Merck & Co Inc

0.88%

0.95%

0.67%

0.84%

0.82%

0.89%

MA

Mastercard Inc.

0.97%

0.82%

0.62%

0.51%

0.54%

0.45%

BA

Boeing Co.

0.78%

0.81%

0.72%

0.46%

0.51%

0.48%

WFC

Wells Fargo & Co

0.78%

0.93%

1.18%

1.29%

1.41%

1.43%

http://siblisresearch.com/data/weights-sp-500-companies/

 

image058.jpg

 

How to Calculate the Weights of Stocks

The weights of your stocks can play a big role in your investment strategy. Here's how to calculate them.

Calculating the weights of stocks you own can be useful to your investment strategy. For example, if your investment goal is to allocate no more than 15% of your portfolio to any single stock, determining the weights of the stocks in your portfolio can tell you whether or not you need to make any changes. Here's how to calculate the weights of stocks, what this information means to you, and an example of how you can use this.

Calculating the weights of stocks
Basically, to determine the weights of each of your stocks, you'll need two pieces of information. First, you'll need the cash values of each of the individual stocks you want to find the weight of.

You'll also need your total portfolio value. If you want to determine the weights of your stock portfolio, simply add up the cash value of all of your stock positions. If you want to calculate the weights of your stocks as a portion of your entire portfolio, take your entire account's value – including stocks, bonds, cash, and any other investments.

The calculation is simple enough. Simply divide each of your stock position's cash value by your total portfolio value, and then multiply by 100 to convert to a percentage.

https://g.foolcdn.com/image/?url=https%3A%2F%2Fg.foolcdn.com%2Feditorial%2Fimages%2F198140%2Fweights.png&w=700&op=resize

What the weights tell you
These weights tell you how dependent your portfolio's performance is on each of your individual stocks. For example, your portfolio's day-to-day fluctuations will depend much more on a stock that makes up 20% of the total than one that only makes up 5%.

So, when your heavily weighted stocks do well, your portfolio can go up quickly. For example, if a stock with a 20% weight in a $50,000 portfolio doubles, it would mean a $10,000 gain. On the other hand, if a stock only makes up 2% of your portfolio, your gain would only be $1,000, even though the stock itself was a home run.

Conversely, heavily weighted stocks can drag your portfolio down during tough times, while lower-weighted stocks will have a smaller effect.

Examining your portfolio: An example
Let's say that you own the following stock investments: $2,000 of Microsoft, $3,000 of Wal-Mart, $2,500 of Wells Fargo, and $4,000 of Johnson & Johnson. A quick calculation shows that your total portfolio value is $11,500, and using the formula mentioned earlier, you can calculate the weights of each of your four stocks:

Stock

Cash Value

Weight

Microsoft

$2,000

17.4%

Wal-Mart

$3,000

26.1%

Wells Fargo

$2,500

21.7%

Johnson & Johnson

$4,000

34.8%

In this example, Johnson & Johnson carries twice the weight of Microsoft; therefore, a big move in J&J will have double the effect on your overall portfolio than the same move in Microsoft would.

 

 

 There are a lot more losing than winning stocks in the S&P 500, Jim Cramer says

PUBLISHED THU, AUG 20 20206:28 PM EDTUPDATED THU, AUG 20 20206:30 PM EDT

Tyler Clifford

KEY POINTS

https://www.cnbc.com/2020/08/20/jim-cramer-the-sp-500-has-a-lot-more-losers-than-winning-stocks.html (video)

 

·         “When you get down into the weeds of this market, what you see is that there are a lot more losers than there are winners,” CNBC’s Jim Cramer said.

·         “That’s the nature of the Covid economy, and now that there’s no one in Washington willing to play gardener, maybe it’s only a matter of time before the weeds overrun the entire patch,” the “Mad Money” host said.

·         “We have a bizarre situation where some companies are doing very well,” Cramer said, “but a lot of other companies are getting crushed.”

The stock market does not appear as strong as the headline numbers in the benchmark index may portray after taking a look at the performances of its components, CNBC’s Jim Cramer said Thursday.

Bottom of Form

While the big tech stocks have made significant gains that carried the S&P 500 back to record levels, most of the stocks in the broad average are down this year, he said.

“When you get down into the weeds of this market, what you see is that there are a lot more losers than there are winners,” said the “Mad Money” host, likening the stock market to a patch of grass. “That’s the nature of the Covid economy, and now that there’s no one in Washington willing to play gardener, maybe it’s only a matter of time before the weeds overrun the entire patch.”

The major averages climbed in Thursday’s session, despite the negative news of 1.1 million new unemployment claims that were filed in the week ended Aug. 15. More than 1 million people applied for weekly jobless benefits in 22 of the last 23 weeks amid a global coronavirus pandemic.

The Dow Jones climbed almost 47 points for a 0.1% gain, breaking a three-day losing streak, to close at 27,739.73. The S&P 500 rose 0.3% to 3,385.51, a handful of points shy of its record close Tuesday, and the Nasdaq Composite rallied 1% to 11,264.95 for a new closing record.

“We have a bizarre situation where some companies are doing very well,” Cramer said, “but a lot of other companies are getting crushed.”

Big Tech names are all up double digits this year with Amazon and Apple, which boasts a $2 trillion valuation, both surging 78% and 61%, respectively, year to date. NvidiaDexComWest Pharmaceutical ServicesPayPal and Abiomed are the top five S&P gainers this year with advances of more than 80%, according to FactSet.

On the losing side are the cruise ships, oil companies, pipelines, retailers, airlines and banks, among others, Cramer pointed out. Norwegian Cruise Line and Carnival, whose stocks are down more than 70% this year, have lost the most value on the benchmark. Occidental PetroleumCoty and TechnipFMC round out the bottom five, all down 60% or more, based on FactSet data.

Kohl’s is the biggest decliner in retail, dropping 63% from the beginning of the year. The company has lost nearly 19% in value this week alone.

The S&P 500 is now up 4.79% year to date.

Covid-19, which has infected at least 5.56 million Americans and been connected to nearly 174,000 deaths in the country, according to data compiled by Johns Hopkins University, and the economic lockdowns implemented to slow the spread have dealt the hardest hand to small businesses. In order to stay afloat in a physically distant and remote world, businesses have had to pivot to the web to connect with consumers.

Most small retailers can’t pivot online fast enough, and many of them will go under without fiscal support from the government, Cramer said.

The S&P 500, however, continues to go higher, thanks to about 40% of the stocks that make up the index, he added.

“That’s pretty incredible, and the lack of breadth here explains a lot more about how the real economy’s doing,” Cramer said, referring back to the grass analogy. “The truth is the weeds are more representative than the healthy patches of lawn, and, in many ways, it’s getting worse, not better, as the weeds begin, I think, to infect the nice part.”

 

For discussion:

·         Do YOU AGREE with Jim Cramer?

·         So Jim Cramer recommend S&P 500 to his followers? Do you agree with him?

·          

 

HW chapter 5 -1 (Due with the second mid-term exam)

1         Calculate the monthly stock return and risk of Apple and SP500 in the past five years. And draw a conclusion regarding the tradeoff between risk and return.

Steps:

From finance.yahoo.com, collect stock prices of the above firms, in the past five years 

Steps:

·        Goto finance.yahoo.com, search for the companies (Apple and S&P500, repectively)

·        Click on “Historical prices” in the left column on the top and choose monthly stock prices.

·        Change the starting date and ending date to “Oct 8th, 2015” and “Oct 8th, 2020”, respectively.

·        Download it to Excel

·        Delete all inputs, except “adj close” – this is the closing price adjusted for dividend.

  Evaluate the performance of each stock:

·        Calculate the monthly stock returns.

·        Calculate the average return

·        Calculate standard deviation as a proxy for risk

 

Please use the following excel file as reference. 

FYI Excel (or template)

 

 

2.      Calculate the most recent weight of Apple in SP500. Also calculate the weight of GOOGLE, Amazon, Netflix.

Hint:  please use $28,125,589.1 millionfor SP500 value. The website for this information is here: http://siblisresearch.com/data/total-market-cap-sp-500.   

 

 

3.     Do you think that Tesla should be added to S&P 500? Refer to Why Tesla was not included in the S&P 500(video)

 

4.     Compare the above top 10 best and worst stocks and give it a try to summarizes about the similarities among stocks in each group, such as location, industry sector, etc. if you can find any.  https://sports.yahoo.com/top-10-best-worst-performing-154850791.html

image059.jpg

 

 

image060.jpg

 

 

 

What Apple’s Stock Split Means for You

·                     By STEVEN RUSSOLILLO

 

 WHAT IF APPLE NEVER SPLIT ITS STOCK? Apple has now split its stock four times throughout its history. It previously conducted 2-for-1 splits on three separate occasions: February 2005, June 2000 and June 1987. According to some back-of-the-envelop math by S&P’s Howard Silverblatt, if Apple never split its stock, you’d have eight shares for each original one prior to the most recent split. So Friday’s $645.57 closing level would translate to $5164.56 unadjusted for splits.

No Here are five things you need to know about Apple’s stock split.

 

WHO DOES THE STOCK SPLIT IMPACT? Investors who owned Apple shares as of June 2 qualify for the stock split, meaning they get six additional shares for every share held. So if an investor held one Apple share, that person would now hold a total of seven shares. Apple also previously paid a dividend of $3.29, which now translates into a new quarterly dividend of $0.47 per share.

 

WHY IS APPLE DOING THIS? The iPhone and iPad maker says it is trying to attract a wider audience. “We’re taking this action to make Apple stock more accessible to a larger number of investors,” Apple CEO Tim Cook   said in April. But the comment also marked an about-face from two years earlier. At Apple’s shareholder meeting in February 2012, Mr. Cook said he didn’t see the point of splitting his company’s stock, noting such a move does “nothing” for shareholders.

 

WILL APPLE GET ADDED TO THE DOW? It’s unclear at the moment, although a smaller stock price certainly makes Apple a more attractive candidate to get added to blue-chip Dow. Apple, the bigge, your screens aren’t lying to you. Shares of Apple Inc. now trade under $100, a development that hasn’t happened in years.

 

Apple’s unorthodox 7-for-1 stock split, announced at the end of April, has finally arrived. The stock started trading on a split-adjusted basis Monday morning, and recently rose 1% to $93.14.

In a stock split, a company increases the number of shares outstanding while lowering the price accordingly. Splits don’t change anything fundamentally about a company or its valuation, but they tend to make a company’s stock more attractive to mom-and-pop investors. Apple shares rallied 23% from late April, when the company announced the split in conjunction with a strong quarterly report, through Friday.

 

A poll conducted by our colleagues at MarketWatch found 50% of respondents said they would buy Apple shares after the split. Some 31% said they already owned the stock and 19% said they wouldn’t buy it. The survey received more than 20,000 responses.

st U.S. company by market capitalization, has never been part of the historic 30-stock index, a factor that many observers attributed to its high stock price. The Dow is a price-weighted measure, meaning the bigger the stock price, the larger the sway for a particular component. That is different from indexes such as the S&P 500, which are weighted by market caps (each company’s stock price multiplied by shares outstanding).

 

WILL APPLE KEEP RALLYING? Since the financial crisis, companies that have split their stocks have struggled in the short term and outperformed the broad market over a longer time horizon. Since 2010, 57 companies in the S&P 500 have split their shares. Those stocks have averaged a 0.2% gain the day they started trading on a split-adjusted basis, according to New York research firm Strategas Research Partners. A month later, they have risen just 0.5%. But longer term, the average gains are more pronounced. Since 2010, these stocks have averaged a 5.4% increase three months after a split and a 28% surge one year later, Strategas says.

 

WHAT IF APPLE NEVER SPLIT ITS STOCK? Apple has now split its stock four times throughout its history. It previously conducted 2-for-1 splits on three separate occasions: February 2005, June 2000 and June 1987. According to some back-of-the-envelop math by S&P’s Howard Silverblatt, if Apple never split its stock, you’d have eight shares for each original one prior to the most recent split. So Friday’s $645.57 closing level would translate to $5164.56 unadjusted for splits.

 

For class discussion:

Why Apple needs to do so? Is that necessary? Why Google does not follow Apple and make its stock price cheaper and affordable?

 

 

 

 

 

 

 

Tesla jumps 12% as stock split takes effect, Apple gains 3%

PUBLISHED MON, AUG 31 202011:20 AM EDTUPDATED MON, AUG 31 20204:26 PM EDT

Fred Imbert

KEY POINTS

·         Monday’s gains are just the latest in a string of strong performances since the companies announced plans for stock splits.

·         Apple said July 30 its board approved a 4-for-1 stock split. Since then, the stock is up more than 32%.

·         Tesla has skyrocketed more than 70% since it announced a 5-for-1 stock split on Aug. 11.

Shares of Apple and Tesla rose sharply Monday, the first day of their stock splits.

Apple advanced 3.4% and was the best-performing component in the Dow Jones Industrial Average. Tesla jumped 12.6%.

Monday’s gains were the latest in a string of strong performances since the companies announced the stock splits.

Apple said July 30 its board approved a 4-for-1 stock split. Since then, the stock is up more than 34%. Tesla has skyrocketed more than 80% since it announced a 5-for-1 stock split on Aug. 11.

Billionaire investor Leon Cooperman, however, said Monday that run-ups on the back of stock-split announcements are a troublesome sign for the market.

“Look at Tesla and Apple: Everybody understands that splits don’t create value,” the founder of Omega Advisors told CNBC’s “Squawk Box.” “My dad once told me if you gave me five singles for a $5 bill, I’m no better off.”

Monday’s gains in Apple and Tesla came amid high volume as smaller traders are able to snap up shares in both companies at a much lower price than on Friday.

Apple traded 223.4 million shares, which is roughly 25% more than the stock’s 30-day volume average of 178.588 million. Tesla shares exchanged hands 115.6 million times, well above its 30-day volume average of 73.369 million.

This year, smaller traders have been more actively participating in the market as commission-free online brokerage Robinhood grows in popularity. But Cooperman sees this as a potential sign of being overheated.

“I see signs of euphoria creeping into the market: the IPO SPAC market is one, [and] the craziness in many of the stocks that the Robinhood crowd has latched onto,” Cooperman said. “You see a Kodak go from $1.50 to $60 and from $60 to $6 in a very short period of time … and when you look into it, it’s the Robinhood crowd taking it up.”

 

 

 

 

 

 

 

 

S&P 500 adds three companies not named Tesla — ‘a bit of a shocker,’ analyst says

By 

Jeremy C. Owens

 

Tesla stock falls in after-hours trading after big run-up amid speculation that car company would get the nod after year of profit; S&P Dow Jones Indices adds Etsy, Catalent and Teradyne instead

 

Three new names will be added to the S&P 500 index this month, but none of them are Tesla Inc.

S&P Dow Jones Indices announced Friday afternoon that it will add three companies to the S&P 500 SPX, +1.74%  — Catalent Inc. CTLT, +3.01%  , Etsy Inc. ETSY, +6.02%  and Teradyne Inc. TER, +1.45% Tesla Inc. TSLA, +2.73%  was thought to be in line for the addition after announcing a fourth consecutive quarter of profitability, a requirement of the index, which many observers cited as a reason for a gigantic increase in the electric-car company’s stock in recent weeks.

“S&P 500 inclusion now likely a done deal,” Wedbush analyst Dan Ives said after Tesla reported a profitable quarter in July.

When reached Friday, Ives said, “The Champagne was on ice to get into the S&P 500, [it] was baked into shares.”

“This was a bit of a shocker and the Street assumed this was a foregone conclusion,” Ives said in an email to MarketWatch. “Tesla not getting into the S&P 500 club is a head scratcher and the stock will likely be down for the indexing implications.”

Ives reiterated his neutral rating on Tesla shares in a note later Friday. Only 22% of sell-side analysts tracked by FactSet consider Tesla a “buy” as of Friday afternoon, which was actually an increase from earlier in the week, but still well lower than other stocks in the S&P 500 index.

Tesla stock has added more than 31% since announcing second-quarter earnings on the afternoon of July 22, though that performance has declined this week — at the end of Monday’s trading session, the stock had gained 56% since earnings. Shares have suffered this week in the wake of a stock split, the announcement of a plan to sell up to $5 billion in fresh shares, and insider selling. Overall, the electric-car company’s shares have still quintupled this year, pushing its market capitalization to $380 billion as of Friday’s closing bell.

Three previous members of the S&P Midcap 400 will move up to the larger index instead, replacing three other companies that moved down to the midcap index, H&R Block Inc. HRB, +2.61%  , Coty Inc. COTY, +9.53%  and Kohl’s Corp. KSS, +5.90%  The changes will take effect before the open of trading on Sept. 21.

Tesla stock fell more than 6% in after-hours trading following the announcement. Catalent shares rose nearly 3%, Etsy shares added more than 5%, and Teradyne stock increased more than 2%. 

For discussion:

·         Do you get suspicious regarding the criteria of S&P?

·         Tesla would be rank #1 in terms of market value if it were added to S& 500 index. Right?

Chapter 5 Part II – Mutual Funds and ETF

 

Mutual fund  ppt

 

Want to improve your personal finances? Start by taking this quiz to get an idea of your investment risk tolerance – one of the fundamental issues to consider when planning your investment strategy, either alone or in consultation with a financial services professional.   

 

 

Investment Risk Tolerance Quiz (take it and access your risk tolerance in investing)

https://njaes.rutgers.edu/money/assessment-tools/investment-risk-tolerance-quiz.pdf

 

Your risk tolerance (the degree of uncertainty you are willing to take on to achieve potentially greater rewards) is determined by a combination of factors, including your investment goals and experience, how much time you have to investyour other financial resources and your “fear factor.”

 

Investment Pyramid: Risk/Return Trade-Offs 

Investments at the top of the pyramid tend to be speculative and some also are illiquid (meaning they are harder to quickly convert into cash without loss of value). While they offer more potential reward, they also carry greater risks for loss of principal than investments at the base of the pyramid. 

Less risky investments at the bottom of the pyramid are more liquid and offer stable (although lower) rates of return. 

 

 

image060.jpg

 

 

Discussion: Based on your risk tolerant score, which of the above shall you choose? Why? Do you have other opinions? Can you invest in both low and high risky products to diversify?

 

 

Example: Optimally diversified portfolio

1.             

3.      image023.jpg

 

 

For class discussion:

1.     What is value stock? Example?

2.     What is small cap value? Example?

3.     What is large value? Example?

4.     Shall we consider bond for diversification purpose?

5.     Shall we include international stocks to establish a diversified portfolio?

6.     What benefits can be gained from diversification with bond and international stocks?

 

 

 

 

 image024.jpg

 

 

 

Mutual fund vs. ETF

Discussion: What is the difference between the two? Pro and con of each?

What is ETF? (Video)

Mutual Funds vs. ETFs - Which Is Right for You? (Video)

 

 image022.jpg

 

 

For discussion:

What one of the above funds is the most favorite one to you? Why?

 

 

image025.jpg

For class discussion:

1.           How to tell the risk level based on standard deviation shown in step 1?

2.           What is the difference between rewarded risk and unrewarded risk? Example?

3.           Write down the CAPM model.

4.           Among the four models shown in step 3, which one is the best?

 

ETF trading (Video)

Dark Side of ETFs CNBC (Video)

ETF Investing Strategies (Video)

 

For class discussion:

What is ETF?

What is the pro and cons to invest in ETF?

Examples of ETF?

 

 

Examples of ETF: Powershares (QQQ) – NASDAQ 100 Index (Large-cap growth stocks)

 

Understanding QQQE: Nasdaq-100 Equal Weighted Index Shares ETF (Video)

 

For class discussion:

When we compare QQQ with S&P500, which one is better in terms of performance in the past ten years?

Which one is riskier? Why?

 

QQQ vs. SPY: Head-To-Head ETF Comparison

QQQ

This ETF offers exposure to one of the world's most widely-followed equity benchmarks, the NASDAQ, and has become one of the most popular exchange-traded products. The significant average daily trading volumes reflect that QQQ is widely used as a trading vehicle, and less as a components of a...

SPY

SPY is one of the largest and most heavily-traded ETFs in the world, offering exposure to one of the most well known equity benchmarks. While SPY certainly may have appeal to investors seeking to build a long-term portfolio and include large cap U.S. stocks, this fund has become extremely popular...

 

 

The table below compares many ETF metrics between QQQ and SPY. Compare fees, performance, dividend yield, holdings, technical indicators, and many other metrics to make a better investment decision.  https://etfdb.com/tool/etf-comparison/QQQ-SPY/#performance

 

                                                                                                         QQQ                                    SPY

 1 Week Return

4.16%

3.90%

2 Week Return

5.21%

5.51%

4 Week Return

5.80%

4.24%

13 Week Return

8.39%

9.65%

26 Week Return

42.70%

25.73%

YTD Return

35.10%

9.31%

1 Year Return

52.56%

20.57%

3 Year Return

98.19%

44.34%

Beta

1.05

1.0

P/E Ratio

30.85

24.17

Annual Dividend Rate

$1.63

$5.68

Dividend Date

2020-09-21

2020-09-18

Dividend

$0.39

$1.34

Annual Dividend Yield %

0.58%

1.65%

5 Day Volatility

236.98%

248.89%

20 Day Volatility

26.87%

18.89%

50 Day Volatility

28.13%

18.33%

200 Day Volatility

25.46%

19.94%

Standard Deviation

31.42%

25.34%

 

image061.jpg

 

 

 Discussion: How to tell the performance of a fund? Return only? The higher the better? Or alpha?

Alpha, often considered the active return on an investment, gauges the performance of an investment against a market index used as a benchmark, since they are often considered to represent the market’s movement as a whole. The excess returns of a fund relative to the return of a benchmark index is the fund's alpha.

Alpha is most often used for mutual funds and other similar investment types. It is often represented as a single number (like 3 or -5), but this refers to a percentage measuring how the portfolio or fund performed compared to the benchmark index (i.e. 3% better or 5% worse).

Alpha is often used with beta, which measures volatility or risk, and is also often referred to as “excess return” or “abnormal rate of return”. (Investorpedia)  

 

What is alpha? video

 

 

The Direxion Daily S&P 500® Bull and Bear 3X Shares Leverage ETFs (video)

 

Leveraged ETF's Explained | Hint: Don't Do It (video)

 

 

 

 

HW chapter 5 -2  (Due with the second mid-term exam)

·        Work on this investment risk tolerance test and report your score. Make a self-evaluation about yourself in terms of your risk tolerance level.

·        Based on your risk level, set up an investment plan. Please provide a rationale.

·        Compare QQQ with SPY. Which one of the two is more suitable to you?  Please provide a rationale.

·        What is alpha?

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The big mistake mutual-fund investors make

Published: Apr 21, 2017 4:04 a.m. ET

 

 11By  PAULA. MERRIMAN

 

  

You have probably heard about what's known as the DALBAR effect. It's the fact that, as a group, mutual-fund investors underperform the funds in which they invest.

Quick background: The reason for this effect, amply documented over nearly a quarter-century by a Boston research firm, is investors' behavior.

 

In short, mutual fund shareholders tend to buy and sell based on their emotional reactions to bull markets and bear markets, real or expected. Their timing is usually wrong, and in the end they would have done better by buying and holding.

 

OK, here's the bad news: If you're average, chances are you will underperform the funds that you own.

But here's the good news: I've discovered a group of investors who are apparently doing just the opposite: They are outperforming the funds they own.

To understand how that's possible, you'll need to bear with me as I walk through some steps. For your patience, you will be rewarded at the end with my suggestion for how you too may be able to perform what seems to be a minor financial miracle.

I first discovered this anomaly while I was comparing target-date retirement funds offered by Fidelity and Vanguard.

What I found is more than just coincidence: It appears in the latest 10-year performance results in four pairs of retirement funds — those with target dates of 2020, 2030, 2040 and 2050.

Let's take the Vanguard and Fidelity 2020 funds as examples. The numbers are clear on two points.

·                     The Vanguard fund has higher returns.

·                     While investors in the Fidelity fund (consistent with the DALBAR effect noted above), achieved lower returns than those of the fund itself, investors in Vanguard's 2020 fund achieved higher results than the fund.

Here are the numbers:

For the 10 years ended March 31, 2017, the Fidelity 2020 Freedom Fund FFFDX  compounded at 4.47%, while investor returns (provided by Morningstar Inc.) were only 3.13%. The Vanguard Target Retirement 2020 Fund VTWNX compounded at 5.23%, and investor returns were 6.53%.

How is it possible to have such a large additional return?

The Vanguard fund return is based on the assumption of a lump-sum initial investment made at the end of March 2007 with no further additions or withdrawals other than reinvestment of dividends.

The investor return tracks the dollars that investors as a group actually invested, and when they invested them. (I'll come back to that point in a moment.)

Here are the comparable results for three other pairs of target-date funds.

2030: Fidelity FFFEX  grew at 4.66%; investor returns were only 3.53%. Vanguard VTHRX   grew at 5.31%; investor returns were 7.58%.

2040: Fidelity FFFFX     grew at 4.78%; investor returns were only 4.17%. Vanguard VFORX, -0.40%   grew at 5.69%; investor returns were 8.49%.

2050: Fidelity FFFHX, -0.41%   grew at 4.61%; investor returns were 6.92%. (No, that's not a typo; stay tuned.) Vanguard VFIFX, -0.39%   grew at 5.71%; investor returns were 8.70%.

In every case, the Vanguard funds achieved higher performance. That's not hard to explain: Fidelity's funds charge higher expenses, hold more cash, use active management and have much higher turnover.

But those things don't explain how investors in five of these eight funds did the seemingly impossible: outperformed the funds in which they invested.

I think the answer is to be found in investor behavior.

Target-date fund shareholders are typically setting money aside methodically for their eventual retirement through regular withdrawals from their paychecks.

 

You probably know the name for this practice: dollar-cost averaging (DCA), investing the same amount every month or every pay period.

DCA lets investors take advantage of the rise and fall of stock prices by automatically buying more shares when prices are low and fewer shares when prices are high. The result: The average price paid per share is lower than the average of all the prices at which those shares were bought.

I think this explains the higher investor returns in five of these eight funds.

Two questions remain:

·                     Why did Vanguard investors outperform while those in three of the four Fidelity funds lagged?

·                     Why did investors in Fidelity's 2050 fund do better than investors in the other three Fidelity funds under study?

Though I can't back up my answers with numbers, I'll take a stab at answering these questions. Both answers, I believe, come down once again to investors' collective behavior.

To answer the first question, I think Vanguard simply attracts a different sort of investor than Fidelity.

·                     Vanguard marketing emphasizes the firm's low costs, its index funds, the higher quality of its stocks and bonds and its buy-and-hold culture. Vanguard urges investors to accept the returns of the market.

·                     Fidelity's marketing focuses on active managers who pick stocks, backed up by impressive stock analysts. Fidelity urges investors to seek higher performance.

OK, but so why did investors in Fidelity's 2050 fund outperform the fund itself, while those in the 2020, 2030 and 2040 funds underperformed?

Here I have to speculate. I'm guessing that investors with an eye on a 2050-ish retirement are younger and often have less money with which they want to try to beat the odds.

 

For this reason, I suspect that such investors are less likely to try to second-guess the market's ups and downs and more likely to simply trust their funds.

I promised a suggestion for how you might be able to outperform a fund you're invested in.

 

My best suggestion is to use dollar-cost averaging. This will keep your average cost-per-share down. And it will keep you investing regularly. Both are extremely good habits.

However, at the risk of throwing cold water on a good idea, I have to point out that DCA makes a positive difference only over extended periods, and only during periods when the market ends up higher than it started. (The reason for this is simple: Even if you buy at below-average prices, if your investment loses money over the long run, it loses money. Sorry about that.)

 

The latest 10-year period (like most 10-year periods) was a positive one for stock investors. The most recent eight years were especially strong, with the S&P 500 index SPX, -0.47%  appreciating by more than 300% (including reinvestment of dividends).

Although things won't always be that good, the market historically goes up about two-thirds of the time and down only one-third.

So if you take a long-term perspective, keep your expectations realistic and adopt excellent investing habits, I think there's a good chance you, like many of Vanguard's target-date investors, will be able to do the seemingly impossible.

 

For discussion:

What is suggested by the author? Do you agree?

 

 

 

 

Investors pulled $3.5 billion out of the biggest tech ETF in a single day — the most since 2000

Matthew Fox

 Sep. 21, 2020, 06:36 PM

 

Investors on Friday pulled $3.5 billion out of the popular Invesco QQQ Trust Series 1 ETF, which tracks the Nasdaq 100 index, according to Bloomberg data.

That marked the biggest single-day outflow since October 2000, amid the dot-com bubble.

The mass exit reflects the unease in the tech sector that's sent the Nasdaq 100 tumbling into correction territory in recent weeks. On Monday, the gauge sat roughly 13% below its September 2 peak.

The Invesco QQQ ETF, the biggest technology exchange-traded fund available to investors, had more than $120 billion in assets as of Friday.

The three-week skid in technology stocks comes as investors grapple with uncertainty surrounding the November presidential election, additional fiscal stimulus measures in response to the COVID-19 pandemic, and the development and rollout of a COVID-19 vaccine.

The Nasdaq 100 is on pace to lose more than 10% in September, which would be its worst month since 2008.

On Monday, despite continued selling in the index, the Nasdaq 100 outperformed the Dow Jones industrial average and the S&P 500, suggesting that investors may warm up to tech stocks again as economic uncertainty persists.

image062.jpg

 

 

 

 

 

Chapter 8 Stock Market

 

Part I: Stock Market Popular Websites

 

ppt 

 

Stock screening tools

Reuters stock screener to help select stocks

http://stockscreener.us.reuters.com/Stock/US/

 

FINVIZ.com

http://finviz.com/screener.ashx

 

WSJ stock screen

http://online.wsj.com/public/quotes/stock_screener.html

 

Stock charts

Simply the Web's Best Financial Charts

 

How to pick stocks

Capital Asset Pricing Model (CAPM)Explained

https://www.youtube.com/watch?v=JApBhv3VLTo

 

Fama French 3 Factor Model Explained

https://www.youtube.com/watch?v=zWrO3snZjuA

 

Ranking stocks using PEG ratio

https://www.youtube.com/watch?v=bekW_hTehNU

 

Class discussion topics and homework (Are the following statements right or wrong? Why?, due with the second mid-term exam) 

1: My investment in company A is a sure thing.

2: I would never buy stocks now because the market is doing terribly.

3: I just hired a great new broker, and I am sure to beat the market.

4: My investments are well diversified because I own a mutual fund that tracks the S&P 500.

5: I made $1,000 in the stock market today.

6: GMs earning report is better than expected. But GM stock price went down instead of going up after the earning news was released. How come?

7: Paypal’s price has gone up so much in the past several months. I should invest in Paypal now.   

 

 

Part II: Behavior Finance

 

 

Behavior Finance Introduction PPT

 

Vanguard Behavior Finance Lecture PPT - FYI

 

Behavior Finance Class Notes  - FYI

 

 

Behavioral Finance  https://www.investopedia.com/terms/b/behavioralfinance.asp

By WILL KENTON  Reviewed By ERIC ESTEVEZ   Updated Jul 28, 2020

 

What Is Behavioral Finance?

Behavioral finance, a sub-field of behavioral economics, proposes that psychological influences and biases affect the financial behaviors of investors and financial practitioners. Moreover, influences and biases can be the source for explanation of all types of market anomalies and specifically market anomalies in the stock market, such as severe rises or falls in stock price.

Understanding Behavioral Finance

Behavioral finance can be analyzed from a variety of perspectives. Stock market returns are one area of finance where psychological behaviors are often assumed to influence market outcomes and returns but there are also many different angles for observation. The purpose of classification of behavioral finance is to help understand why people make certain financial choices and how those choices can affect markets. Within behavioral finance, it is assumed that financial participants are not perfectly rational and self-controlled but rather psychologically influential with somewhat normal and self-controlling tendencies.

One of the key aspects of behavioral finance studies is the influence of biases. Biases can occur for a variety of reasons. Biases can usually be classified into one of five key concepts. Understanding and classifying different types of behavioral finance biases can be very important when narrowing in on the study or analysis of industry or sector outcomes and results.

KEY TAKEAWAYS

  • Behavioral finance is an area of study focused on how psychological influences can affect market outcomes.
  • Behavioral finance can be analyzed to understand different outcomes across a variety of sectors and industries.
  • One of the key aspects of behavioral finance studies is the influence of psychological biases.

 

Behavioral Finance Concepts

Behavioral finance typically encompasses five main concepts:

  • Mental accounting: Mental accounting refers to the propensity for people to allocate money for specific purposes.
  • Herd behavior: Herd behavior states that people tend to mimic the financial behaviors of the majority of the herd. Herding is notorious in the stock market as the cause behind dramatic rallies and sell-offs.
  • Emotional gap: The emotional gap refers to decision making based on extreme emotions or emotional strains such as anxiety, anger, fear, or excitement. Oftentimes, emotions are a key reason why people do not make rational choices.
  • Anchoring: Anchoring refers to attaching a spending level to a certain reference. Examples may include spending consistently based on a budget level or rationalizing spending based on different satisfaction utilities. 
  • Self-attribution: Self-attribution refers to a tendency to make choices based on a confidence in self-based knowledge. Self-attribution usually stems from intrinsic confidence of a particular area. Within this category, individuals tend to rank their knowledge higher than others.

Biases Studied in Behavioral Finance

Breaking down biases further, many individual biases and tendencies have been identified for behavioral finance analysis, including:

Disposition Bias

Disposition bias refers to when investors sell their winners and hang onto their losers. Investors' thinking is that they want to realize gains quickly. However, when an investment is losing money, they'll hold onto it because they want to get back to even or their initial price. Investors tend to admit they are correct about an investment quickly (when there's a gain). However, investors are reluctant to admit when they made an investment mistake (when there's a loss). The flaw in disposition bias is that the performance of the investment is often tied to the entry price for the investor. In other words, investors gauge the performance of their investment based on their individual entry price disregarding fundamentals or attributes of the investment that may have changed.

Confirmation Bias

Confirmation bias is when investors have a bias toward accepting information that confirms their already-held belief in an investment. If information surfaces, investors accept it readily to confirm that they're correct about their investment decision—even if the information is flawed.

Experiential Bias

An experiential bias occurs when investors' memory of recent events makes them biased or leads them to believe that the event is far more likely to occur again. For example, the financial crisis in 2008 and 2009 led many investors to exit the stock market. Many had a dismal view of the markets and likely expected more economic hardship in the coming years. The experience of having gone through such a negative event increased their bias or likelihood that the event could reoccur. In reality, the economy recovered, and the market bounced back in the years to follow.

Loss Aversion

Loss aversion occurs when investors place a greater weighting on the concern for losses than the pleasure from market gains. In other words, they're far more likely to try to assign a higher priority on avoiding losses than making investment gains. As a result, some investors might want a higher payout to compensate for losses. If the high payout isn't likely, they might try to avoid losses altogether even if the investment's risk is acceptable from a rational standpoint.

Familiarity Bias

The familiarity bias is when investors tend to invest in what they know, such as domestic companies or locally owned investments. As a result, investors are not diversified across multiple sectors and types of investments, which can reduce risk. Investors tend to go with investments that they have a history with or have familiarity.

Behavioral Finance in the Stock Market

The efficient market hypothesis (EMH) says that at any given time in a highly liquid market, stock prices are efficiently valued to reflect all the available information. However, many studies have documented long-term historical phenomena in securities markets that contradict the efficient market hypothesis and cannot be captured plausibly in models based on perfect investor rationality.

The EMH is generally based on the belief that market participants view stock prices rationally based on all current and future intrinsic and external factors. When studying the stock market, behavioral finance takes the view that markets are not fully efficient. This allows for observation of how psychological factors can influence the buying and selling of stocks.

The understanding and usage of behavioral finance biases is applied to stock and other trading market movements on a daily basis. Broadly, behavioral finance theories have also been used to provide clearer explanations of substantial market anomalies like bubbles and deep recessions. While not a part of EMH, investors and portfolio managers have a vested interest in understanding behavioral finance trends. These trends can be used to help analyze market price levels and fluctuations for speculation as well as decision-making purposes.

 

Behavioral Finance | Investor Irrationality (video)

 

Examples:

 

1.     Prospect Theory (explained in a minute) - Behavioural Finance

 

2.     Confirmation Bias (explained in a minute) - Behavioural Finance

 

3.     Overconfidence (explained in a minute) - Behavioural Finance

 

4.     Gambler's Fallacy (explained in a minute) - Behavioural Finance

 

5.     Anchoring (explained in a minute) - Behavioural Finance

 

6.     Herd Behaviour (explained in a minute) - Behavioural Finance

 

7.     Overreaction (explained in a minute) - Behavioural Finance

 

8.     Trading Bias: Disposition Effect (video)

 

 

 

THE BEHAVIORAL INVESTOR (BY DANIEL CROSBY)

 

 

 

Homework: (due with the second mid-term exam) 

·        Among the 7 biases explained in the above videos, pick three biases that have the biggest impact on you, and explain what they are using examples. 

·        What is behavior finance? Why is it important?

 

 

 How To Use Behavioral Finance To Make Money? (FYI)

 

Saidrasul Nasretdinov

Value, Growth At Reasonable Price, portfolio strategy, ETF investing

https://seekingalpha.com/article/4087813-how-to-use-behavioral-finance-to-make-money

 

Summary

The topic of this article is to use some of the behavioral biases of investors to generate alpha.

In the first section of this article, well discuss how to take advantage of loss aversion.

In the first section of this article, well discuss how to take advantage of temporal discounting.

Haven't we heard enough about how typical investor is not fully rational and does not really epitomize "economic man"?! In their 1979 paper published in Econometrica, Kahneman and Tversky found the median coefficient of loss aversion to be about 2.25, i.e., losses bite about 2.25 times more than equivalent gains. But, understanding the theory, various biases, and why those might exist and persist is only useful if you have an intellectual curiosity about the topic of behavioral finance. What about using this knowledge to generate alpha over the long-term?

Leverage "loss aversion" to generate alpha

Fortunately, the desire to come up with practical applications for investors has sparked quite a bit of research. Namely, in the research conducted by Goldman Sachs team, they found that 5% OTM calls historically exhibited 69% win rate, while 5% OTM short puts 92% win rate. What's the takeaway:

1.      Long call and short put positions offer a pretty good win rates

2.      Option traders clearly exhibit loss aversion, which is clear from higher win rate offered by short puts vs. long calls. Fear is more potent emotion than greed.

Of course, win rate does not equate to alpha, as you might be losing a lot when trade is in a loss position and make a little during "win" cases. Additionally, one can argue that option win rates mentioned above correspond to typical market gyrations; i.e. market tends to be in an up-cycle longer than in a down-cycle. The Bulls climb up the stairs and the Bears fall out the window.

You would think that market would price options in a way that would ensure no arbitrage. This might be the case. Others might argue that going long calls is similar to leveraged stock investing, i.e. multiple exposures to beta. So, by going long you have good win rate and likely handsome payoff thanks to levered beta exposure. Going short, on another hand, is similar to selling an insurance policy. This works most of the time (seems around 92% of a time), but when it doesn't it can wipe your entire position out. Remember AIG (NYSE:AIG) in 2008 (that was short CDS position… but short put options have very similar payoff characteristics)?

image066.jpg

In other words, I'm not recommending going long calls an shorting puts. You would think that market should get to no-arbitrage pricing at some point. Additionally, this strategy would not be suitable for many. However, if you know how to manage "wipe-out" risk, you might be willing to leverage others' loss aversion to your advantage.

An example of how to use "win" rate in practice (remember, "win" rate is not equivalent to rate of return)

Thanks to comments from the readers of this article (particularly, thanks to Silent Trader), I realized that it is not sufficient to limit the discussion to "win" rate. Instead, I should highlight how "win" rates could be leveraged by traders to generate profit. At the end of the day, you will not be a winner if you win $1 in 69% of a time and lose $10 in 31% of a time. Expected outcome of such bet is negative. So, how one can fix this issue and still take advantage of "win" rates. traders can utilize the knowledge about "win" rates to devise a strategy involving loss-limit rules that would allow them to take advantage most (if not all) of the upside while limiting downsize to a particular level.

Given that "win" rate is in their favor, they should be able to generate handsome returns through limiting downside. Why do I think this should work? Because Martingale System works even for roulette (where "win" rate is lower than 50%) and in this case, one needs to figure out how to equalize payoff and loss amounts in case of "win" and "lose".

So, how one can fix this issue and still take advantage of "win" rates. You just need to find a way to have dollar impact of "win" and dollar impact of "loss" scenarios equal to each other. One needs to figure out how to equalize payoff and loss amounts in case of "win" and "lose".

For instance, if investor made 40% return when long call position work out ("win"), she might set 40% drawdown limit when she rolls the position. Loss-limit rule is likely to increase her chance of "loss", i.e. she might be stopped over more often. However, you might run historical backtest to find a point where "win" rate would still be higher than 50%. Even then there are cases when market liquidity dries up and one might not have actual quotes. In this case, neither stop losses or similar tools would help.

Furthermore, one can argue that market's propensity for over-reacting to fear is already priced into the pricing of put options. Therefore, observation of "win" rates could be nothing but a reflection of asymmetry of payoffs.

Leverage "temporal discounting" to generate alpha

Temporal discounting is the tendency of people to discount rewards as they approach a temporal horizon. To put it another way, it is a tendency to give greater value to rewards as they move away from their temporal horizons and towards the "now". For instance, a nicotine deprived smoker may highly value a cigarette available any time in the next 6 hours but assign little or no value to a cigarette available in 6 months.

Applying temporal discounting to option pricing, one might realize that supply-demand dynamics might lead to relatively cheap, longer dated maturities. One might argue that people would not be trapped in temporal discounting when it comes to option pricing. Don't we all use IV's calculated using Black-Scholes? Yes, we do. However, don't forget that our models assume that volatility increases with the square root of time and that IV levels are driven by actual demand (and supply) dynamics.

Trending markets and the fact that momentum factor worked its magic, one can clearly see that volatility does not increase with the square root of time in practice. Hence, volatility is typically underpriced for longer dated options. This makes LEAPs a somewhat cheap instrument over the long-term (you might be interested in Jamie Mai's points covered on this topic). Of course, there will be times when IV jumps due to market fear, however over the long term, human nature (temporal discounting) is likely to keep the price of LEAPs cheaper than they should be.

Conclusion

Investors might be able to take advantage of market's "loss aversion" by rolling long call and short put positions. However, this approach comes at the expense of "wipe-out" risk. Keep the AIG 2008 experience in mind!

Temporal discounting is another behavioral bias that is unlikely to change. Want to take advantage of it? Consider buying longer dated options (LEAPs) instead of shorter-term options for your option rolling strategy.

 

Disclosure: I am/we are long SPY, IWM, EEM, QQQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

 

Additional disclosure: I'm long call LEAPs on SPY, IWM, EEM, QQQ

 

 

Behavioral Finance and the Role of Psychology

(video,  FYI, a class taught by Dr. Shiller at Yale, the Noble winner)

https://www.youtube.com/watch?v=chSHqogx2CI

Chapter 9 Options and Futures

 

PPT

 

Part I: Options 

 

Class discussion topics:

·         Apple price will go up because of the holiday shopping season. Google price could fall based on some news you just heard. Anticipating large changes in stock prices of Apple and Google, how shall you act?

·         You just bought GM stocks. You worried for GM price might fall. What can you do to ease your mind?

 

Options are derivative contracts that give the holder the right, but not the obligation, to buy or sell the underlying  instrument at a specified price on or before a specified future date. Although the holder (also called the buyer) of the option is not obligated to exercise the option, the option writer (known as the seller) has an obligation to buy or sell the underlying instrument if the option is exercised.
Depending on the strategy, option trading can provide a variety of benefits including the security of limited risk and the advantage of leverage. Options can protect or enhance an investors portfolio in rising, falling and neutral markets. Regardless of the reasons for trading options or the strategy employed, it is important to understand the factors that determine the value of an option. This tutorial will explore the factors that influence option pricing, as well as several popular option pricing models that are used to determine the theoretical value of options. (www.investopedia.com)


 
CBOE free option calculator (great tool to calculate option prices)

 

 Call and Put price of AAPL on Google Finance

Call and Put price of AAPL on Nasdaq

 

Call Options & Put Options Explained Simply In 8 Minutes 

 

 

 Part II: Futures 

Futures market explained (video)

 

Discussion Topics:

·          

 Future market

image030.jpg

F = forward rate

S = spot rate

r1 = simple interest rate of the term currency

r2 = simple interest rate of the base currency

 

 

 

Example of Future market – Bitcoin

·         

https://www.cmegroup.com/trading/equity-index/us-index/bitcoin.html

 

·         Market data is delayed by at least 10 minutes.

·        
All market data contained within the CME Group website should be considered as a reference only and should not be used as validation against, nor as a complement to, real-time market data feeds. Settlement prices on instruments without open interest or volume are provided for web users only and are not published on Market Data Platform (MDP). These prices are not based on market activity.

 

 

MONTH

OPTIONS

CHARTS

LAST

CHANGE

PRIOR SETTLE

OPEN

HIGH

LOW

VOLUME

HI / LOW LIMIT

UPDATED

OCT 2020

OCT 2020

Show Price Chart

13105

+60

13045

13050

13180

13025

476

16955 / 9135

01:30:52 CT
27 Oct 2020

NOV 2020

NOV 2020

Show Price Chart

13260

+80

13180

13190

13310

13190

122

17130 / 9230

01:29:19 CT
27 Oct 2020

DEC 2020

DEC 2020

Show Price Chart

13400

+115

13285

13400

13425

13390

18

17270 / 9300

22:45:31 CT
26 Oct 2020

JAN 2021

JAN 2021

Show Price Chart

13510

+140

13370

13505

13510

13505

6

17380 / 9360

01:24:52 CT
27 Oct 2020

FEB 2021

FEB 2021

Show Price Chart

-

-

13420

-

-

-

0

17445 / 9395

21:12:25 CT
26 Oct 2020

MAR 2021

MAR 2021

Show Price Chart

-

-

13460

-

-

-

0

17495 / 9425

21:12:25 CT
26 Oct 2020

APR 2021

APR 2021

Show Price Chart

-

-

0

-

-

-

0

No Limit / No Limit

18:21:33 CT
26 Oct 2020

DEC 2021

DEC 2021

Show Price Chart

-

-

14215

-

-

-

0

18475 / 9955

21:12:25 CT
26 Oct 2020

 

 

Top of Form

All market data contained within the CME Group website should be considered as a reference only and should not be used as validation against, nor as a complement to, real-time market data feeds. Settlement prices on instruments without open interest or volume are provided for web users only and are not published on Market Data Platform (MDP). These prices are not based on market activity.

https://www.cmegroup.com/trading/equity-index/us-index/bitcoin_quotes_settlements_futures.html

·          

Bottom of Form

MONTH

OPEN

HIGH

LOW

LAST

CHANGE

SETTLE

ESTIMATED VOLUME

PRIOR DAY OPEN INTEREST

OCT 20

13100.0

13300.0

12805.0

13035.0

+75.

13045.0

6,031

7,928

NOV 20

13205.0

13445.0B

12945.0

13160.0

+70.

13180.0

1,519

2,279

DEC 20

13300.0

13560.0B

13070.0

13310.0A

+70.

13285.0

499

1,719

JAN 21

13370.0

13655.0B

13180.0A

13345.0A

+70.

13370.0

168

177

FEB 21

-

13680.0B

13260.0A

13680.0B

+70.

13420.0

0

14

MAR 21

-

13740.0B

13335.0A

13740.0B

+70.

13460.0

0

5

DEC 21

-

-

-

-

+70.

14215.0

0

3

Total

8,217

12,125

 

 

 

·          

o          Home Work and class discussion questions (Due with the second mid term)    

Please refer the articles on the right and answer the following questions.

1.      Who are the buyers and sellers of the futures contract?

2.      Why is there a futures market for bitcoin? 

 

Gambling on Derivatives, Hedging Risk or Courting Disaster?

 

Bullish option strategies example on optionhouse

 

 

Bearish option strategies example on optionhouse

 

  

Options on bitcoin futures just launched. Here’s what you need to know

Scott Nations, Contributor

 

They’re finally here. Exchange-traded bitcoin options launched Monday on the Chicago Mercantile Exchange.

Traders of all stripes have been desperate for exchange-traded options on bitcoin because options can be used to define risk while expressing nearly any market thesis and it is that ability to limit losses that is so important in bitcoin, which saw a 1,900% rally in 2017 followed by an 82% break before bottoming late in 2018.

image068.jpg

Traditional options allow the buyer of the option to purchase the underlying asset in the case of a call option or sell the underlying in the case of a put option. Options on futures are just a bit different in that the owner of a call option has the right at option expiration to take a long position in the bitcoin futures contract traded at the CME, while the owner of a put option has the right to take a short position in those bitcoin futures.

Regardless of the underlying instrument, the ability to define risk comes at a cost. Options on bitcoin futures are incredibly expensive as you would expect from anything with this sort of volatility. Traders usually refer to the cost of an option in terms of “implied volatility,” or the amount of volatility implied by that current price of the option.

Options on bitcoin futures are implying an extreme amount of volatility. Just after midday on Monday, the $8,000-strike put options expiring in April were trading at 72% implied volatility, suggesting that traders believe bitcoin is likely to be between $6,965 and $9,940 when those April options expire. That’s a range of 37% with bitcoin futures at $8,130. In comparison, the at-the-money April options for the S&P 500 are trading below 12% implied volatility.

The buyer of a $9,000-strike call option expiring in April would have to pay about $1,075 for the call, meaning bitcoin futures would have to be above $10,075 for that call purchase to be profitable at expiration. The buyer of an $8,000-strike put option expiring in April would have to pay about $1,165, meaning bitcoin futures would have to be below $6,835 at expiration for the put purchase to be profitable. That would really require some movement.

Until options on bitcoin futures gain a deeper following, any trader will face a market — meaning the bid for any option and the offer price for that option — that is very wide. For example, the market for those April $8,000 put options is about 250 points wide.

That doesn’t mean option sellers will have it any better off. The seller of a naked call option would face unlimited losses if bitcoin were to resume the rally it enjoyed in 2017.

Options on bitcoin futures will likely be a great tool for speculators in the cryptocurrency space. Speculators in other asset classes have known for a long time that options offer the ability to limit losses and create unique payoff profiles. And it’s always good for investors and speculators to have more options.

Scott Nations is a CNBC contributor and president of Nations Indexes, a financial engineering firm.

 

Bitcoin Futures - What You Need To Know (Hint: It's Good News), BTC As Currency, CNBC - CMTV Ep75 (video, FYI)

 

Second Mid Term – 62 T/F questions on 10/29/2020

 

Chapter 11 Commercial Banking System

 

Ppt 1 commercial banking 

PPT2 Commercial banking II (Balance sheet)

 

image028.jpg

 

Wells Fargo’s Income Statement and balance sheet  http://www.nasdaq.com/symbol/wfc/financials?query=balance-sheet

 

Period Ending:

12/31/2019

12/31/2018

12/31/2017

12/31/2016

Total Revenue

$103,915,000

$101,060,000

$97,741,000

$94,176,000

Cost of Revenue

$8,635,000

$5,622,000

$3,013,000

$1,395,000

Gross Profit

$0

$0

$0

$0

Operating Expenses

Research and Development

$0

$0

$0

$0

Sales, General and Admin.

$58,070,000

$55,068,000

$57,332,000

$51,185,000

Non-Recurring Items

$0

$0

$0

$0

Other Operating Items

$2,795,000

$2,802,000

$3,680,000

$4,962,000

Operating Income

$0

$0

$0

$0

Add'l income/expense items

$0

$0

$0

$0

Earnings Before Interest and Tax

$34,415,000

$37,568,000

$33,716,000

$36,634,000

Interest Expense

$10,217,000

$9,030,000

$6,339,000

$4,514,000

Earnings Before Tax

$24,198,000

$28,538,000

$27,377,000

$32,120,000

Income Tax

$4,157,000

$5,662,000

$4,917,000

$10,075,000

Minority Interest

$2,843,000

$1,515,000

$1,779,000

$1,103,000

Equity Earnings/Loss Unconsolidated Subsidiary

-$492,000

-$483,000

-$277,000

-$107,000

Net Income-Cont. Operations

$22,392,000

$23,908,000

$23,962,000

$23,041,000

Net Income

$19,549,000

$22,393,000

$22,183,000

$21,938,000

Net Income Applicable to Common Shareholders

$17,938,000

$20,689,000

$20,554,000

$20,373,000

 

 

Period Ending:

12/31/2019

12/31/2018

12/31/2017

12/31/2016

Current Assets

Cash and Cash Equivalents

$808,756,000

$793,331,000

$831,835,000

$769,111,000

Short-Term Investments

$0

$0

$0

$0

Net Receivables

$0

$0

$0

$0

Inventory

$0

$0

$0

$0

Other Current Assets

$0

$0

$0

$0

Total Current Assets

$0

$0

$0

$0

Long-Term Assets

Long-Term Investments

$1,568,119,000

$1,525,758,000

$1,528,683,000

$1,492,375,000

Fixed Assets

$9,309,000

$8,920,000

$8,847,000

$8,333,000

Goodwill

$26,390,000

$26,418,000

$26,587,000

$26,693,000

Intangible Assets

$0

$0

$0

$0

Other Assets

$80,347,000

$81,293,000

$91,668,000

$115,947,000

Deferred Asset Charges

$0

$0

$0

$0

Total Assets

$1,927,555,000

$1,895,883,000

$1,951,757,000

$1,930,115,000

Current Liabilities

Accounts Payable

$75,163,000

$69,317,000

$70,615,000

$57,189,000

Short-Term Debt / Current Portion of Long-Term Debt

$104,512,000

$105,787,000

$103,256,000

$96,781,000

Other Current Liabilities

$1,322,626,000

$1,286,170,000

$1,335,991,000

$1,306,079,000

Total Current Liabilities

$0

$0

$0

$0

Long-Term Debt

$9,079,000

$8,499,000

$8,796,000

$14,492,000

Other Liabilities

$0

$0

$0

$0

Deferred Liability Charges

$0

$0

$0

$0

Misc. Stocks

$838,000

$900,000

$1,143,000

$916,000

Minority Interest

$0

$0

$0

$0

Total Liabilities

$1,740,409,000

$1,699,717,000

$1,744,821,000

$1,730,534,000

Stock Holders Equity

Common Stocks

$9,136,000

$9,136,000

$9,136,000

$9,136,000

Capital Surplus

$166,697,000

$158,163,000

$145,263,000

$133,075,000

Retained Earnings

-$68,831,000

-$47,194,000

-$29,892,000

-$22,713,000

Treasury Stock

$61,049,000

$60,685,000

$60,893,000

$60,234,000

Other Equity

-$2,454,000

-$7,838,000

-$3,822,000

-$4,702,000

Total Equity

$187,146,000

$196,166,000

$206,936,000

$199,581,000

Total Liabilities & Equity

$1,927,555,000

$1,895,883,000

$1,951,757,000

$1,930,115,000

 

Wells Fargo’s Financial Ratios  

 

image069.jpg

 

For class discussion

1.     Anything wrong with the above balance sheet of Wells Fargo? Where do the loans and deposits go? Is the debt ratio too high? A concern?

Finance & Accounting Facts : Understanding Bank Financial Statements (VIDEO)

FRM: Bank Balance Sheet & Leverage Ratio (VIDEO)

 

2.     Why do we need banks?

                   How did banks develop? A short history of the banking industry. (February 2013, video)

                   Wells Fargo Documentary (video)

 

3.     NIM – Net interest Margin – the profitability measure of banks

 

Net Interest Margin (Video)   https://www.investopedia.com/terms/n/netinterestmargin.asp

By ANDREW BLOOMENTHAL

 Reviewed By DAVID KINDNESS

 Updated Jul 13, 2020

 

Net interest margin (NIM) is a measurement comparing the net interest income a financial firm generates from credit products like loans and mortgages, with the outgoing interest it pays holders of savings accounts and certificates of deposit (CDs). Expressed as a percentage, the NIM is a profitability indicator that approximates the likelihood of a bank or investment firm thriving over the long haul. This metric helps prospective investors determine whether or not to invest in a given financial services firm by providing visibility into the profitability of their interest income versus their interest expenses.

 

Simply put: a positive net interest margin suggests that an entity operates profitably, while a negative figure implies investment inefficiency. In the latter scenario, a firm may take corrective action by applying funds toward outstanding debt or shifting those assets towards more profitable investments.

 

image070.jpg

 

Consider the following fictitious example: Assume Company ABC boasts a return on investment of $1,000,000, an interest expense of $2,000,000, and average earning assets of $10,000,000. In this scenario, ABC's net interest margin totals -10%, indicating that it lost more money due to interest expenses than it earned from its investments. This firm would likely fare better if it used its investment funds to pay off debts rather than making this investment.

 

What Affects Net Interest Margin

Multiple factors may affect a financial institution's net interest margin--chief among them: supply and demand. If there's a large demand for savings accounts compared to loans, net interest margin decreases, as the bank is required to pay out more interest than it receives. Conversely, if there's a higher demand in loans versus savings accounts, where more consumers are borrowing than saving, a bank's net interest margin increases.

 

Monetary policy and fiscal regulation can impact a bank's net interest margin as the direction of interest rates dictate whether consumers borrow or save.

Monetary policies set by central banks also heavily influence a bank's net interest margins because these edicts play a pivotal role in governing the demand for savings and credit. When interest rates are low, consumers are more likely to borrow money and less likely to save it. Over time, this generally results in higher net interest margins. Contrarily, if interest rates rise, loans become costlier, thus making savings a more attractive option, which consequently decreases net interest margins.

 

image071.jpg

 

https://fred.stlouisfed.org/series/USNIM

 

image072.jpg

 

http://www.bankregdata.com/allIEmet.asp?met=NIM&den=aa

 

4.     What is bank run? It is rare. Why?

·        A bank run happens when large groups of customers withdraw their money from banks simultaneously based on fears that the institution will become insolvent.

·        With more people withdrawing money, banks will use up their cash reserves and ultimately end up defaulting.

·        The Federal Deposit Insurance Corporation was established in 1933 in response to a bank run.

Preventing Bank Runs

In response to the turmoil of the 1930s, governments took several steps to diminish the risk of future bank runs. Perhaps the biggest was establishing reserve requirements, which mandate that banks maintain a certain percentage of total deposits on hand as cash. 

 

Additionally, the U.S. Congress established the Federal Deposit Insurance Corporation (FDIC) in 1933. Created in response to the many bank failures that happened in the preceding years, this agency insures bank deposits. Its mission is to maintain stability and public confidence in the U.S. financial system.

 

But in some cases, banks need to take a more proactive approach if faced with the threat of a bank run. Here's how they may do it.

 

o   Slow it down. Banks may choose to shut down for a period of time if they are faced with the threat of a bank run. This prevents people from lining up and pulling their money out. Franklin D. Roosevelt did this in 1933 after he assumed office. He declared a bank holiday, calling for inspections to ensure banks' solvency so they could continue operating.

 

o   Borrow. Banks may borrow from other institutions if they don't have enough cash reserves. Large loans may stop them from going bankrupt.

 

o   Insure deposits. When people know their deposits are insured by the government, their fear generally subsides. This has been the case since the U.S. established the FDIC.

 

               Bank Runs Explained in One Minute: How Banks Become Insolvent and Fail (Video)

                What is the FDIC? (video)

 

5.     Why are banks reluctant to lend out to small business, but offer loans to homebuyers?

                Mark Cuban Says Some Banks 'Actively' Avoiding Small Business Loans (video)

 

 

6.     The regulation: Basel III

For example, the bank has one million dollars that can be lent out. Shall the bank lend it out to a small business owner or to a house buyer?

Use the following information to make your judgment.

     Risk level of     Example

0%       US gov bond

20%     Muni issued by city, state, and Fannie and Freddie

50%     Mortgage

100%   Anything else such as loans to business

Basel III requires 7% of capital based on the risk weighted assets (RWA). 

 

               Basel III in 10 minutes (video)

 

Basel III is a 2009 international regulatory accord that introduced a set of reforms designed to mitigate risk within the international banking sector, by requiring banks to maintain proper leverage ratios and keep certain levels of reserve capital on hand.

Basel III was rolled out by the Basel Committee on Banking Supervision—then a consortium of central banks from 28 countries, shortly after the credit crisis of 2008. Although the voluntary implementation deadline for the new rules was originally 2015, the date has been repeatedly pushed back and currently stands at January 1, 2022.

·        Basel III is an international regulatory accord that introduced a set of reforms designed to improve the regulation, supervision, and risk management within the banking sector.

·        Basel III is an iterative step in the ongoing effort to enhance the banking regulatory framework.

·        A consortium of central banks from 28 countries published Basil III in 2009, largely in response to the credit crisis resulting from the 2008 economic recession.

 

Understanding Basel III

Basel III, which is alternatively referred to as the Third Basel Accord or Basel Standards, is part of the continuing effort to enhance the international banking regulatory framework. It specifically builds on the Basel I and Basel II documents in a campaign to improve the banking sector's ability to deal with financial stress, improve risk management, and promote transparency. On a more granular level, Basel III seeks to strengthen the resilience of individual banks in order to reduce the risk of system-wide shocks and prevent future economic meltdowns.

 

Minimum Capital Requirements by Tiers

Banks have two main silos of capital that are qualitatively different from one another. Tier 1 refers to a bank's core capital, equity, and the disclosed reserves that appear on the bank's financial statements. In the event that a bank experiences significant losses, Tier 1 capital provides a cushion that allows it to weather stress and maintain a continuity of operations. By contrast, Tier 2 refers to a bank's supplementary capital, such as undisclosed reserves and unsecured subordinated debt instruments that must have an original maturity of at least five years.

 

7.     Why banks failed?

          ECONOMICS - Mervyn King - Why banks fail (video)

 

For discussion:

 

·         If a bank is in trouble, who can save them?

·         What causes a bank to be insolvent?

 

 

8.           Too big to fail.  

     What is too big to fail (Bloomberg university) video

Warren Buffett on Too Big to Fail (video)

How can you tell that banks are getting bigger and bigger? Who need big banks? --- for class discussion 

image025.jpg

 

Homework Chapter 11 (Due with final)

 

Question 1: Pick a commercial bank in US and an investment bank. Compare the two companies in terms of firm assets, liability and equity, scope of business, ROE, in 2019. Draw conclusions based on your observation.

 

Question 2: what is bank run? Shall we worry about the occurrence of bank run? Why or why not?

 

Question 3: What is Basel III? Should the government regulate banks?

 

Question 4: What is too big to fail? How can a bank become so big? Can a big bank fail? Why or why not?

 

Question 5: Why is hard for small business to get loan from banks? (read the paper on the right)

 

Examples of investment banks (FYI)

 

·          How does the banking system work part 1. 

https://www.youtube.com/watch?v=Ssa5WNnbGsw&feature=relmfu

 

·          How does the banking system work part 2. 

https://www.youtube.com/watch?v=bhBQizelZP8&list=ULbhBQizelZP8

 

 

Why banks lending to small business isn’t recovering?

By Brayden McCarthy, 9/9/2020

https://www.fundera.com/business-loans/guides/bank-lending-small-businesses-isnt-recovering

 

When you hear the words small business lender, you may imagine a calculator-clutching community banker who spends his time carefully scrutinizing entrepreneurs financial statements. But increasingly these days thats anachronistic. Banks have moved from being community-focused to being Fed-focused, and small business lending is less of a priority. Thats why if you talk to any small business owner about the biggest obstacles to their growth, it wont take long for the conversation to turn to capital access.

In fact, about 80 percent of small business owners who apply for a bank loan get rejected. That’s a staggering number, and its easy to think that this is just a ripple effect of the financial crisis of 2008. After all, banks almost by definition tighten the credit spigot during a banking crisis, and theres no question that the crash is partly responsible for the 20 percent decline in small-business lending from the pre-crisis boom. Moreover, terms on small business loans tightened during the crisis, and have loosened much less for small firms than for large firms during the recovery.

But, thats not the whole story. The truth is that over the past two decades, small business loans have fallen from about half to under 30 percent of total bank loans. That secular decline is due to a multitude of factors, including high transaction costs of small business loans and regulators that push banks to hold more capital against business loans than consumer loans, further driving up the costs of small-business lending.

As a result, it’s increasingly difficult for small businesses to find banks willing to lend to them. One study, for example, noted that the average small business owner has to approach multiple banks and spend about three to four full days of man hours filling out applications before they can find a bank willing to lend to them. So, instead of catalyzing the recovery, bank credit markets are choking off growth and job creation for some small businesses. That’s a dangerous dynamic, and we need to arrest it.

I recently co-authored an independent Harvard Business School working paper entitled ‘The State of Small Business Lending: Credit Access During the Recovery and How Technology May Change the Game’ that bifurcates the problem, which can be accessed here. Below we include an excerpt from the papers executive summary.

Excerpt from The State of Small Business Lending: Credit Access During the Recovery and How Technology May Change the Game

Small businesses are critical to job creation in the U.S. economy.

Small businesses create two out of every three net new jobsSmall firms employ half of the private sector workforce, and since 1995 small businesses have created about two out of every three net new jobs65 percent of total net job creation. Most small businesses are Main Street businesses or sole proprietorshipsOf America’s 28.7 million small businesses, half of all small firms are home-­based, and 23 million are sole proprietorships. The remaining 5.7 million small firms have employees, and can be divided up into Main Street mom and pop businesses, small-­and medium-­sized suppliers to larger corporations, and high-­growth startups.

Small businesses were hit harder than larger businesses during the 2008 financial crisis, and have been slower to recover from a recession of unusual depth and duration.

Small firms were hit harder than large firms during the crisis, with the smallest firms hit hardestBetween 2007 and 2012, the small business share of total net job losses was about 60 percent. From the employment peak before the recession until the last low point in March 2009, jobs at small firms fell about 11 percent. By contrast, payrolls at larger businesses shrank by about 7 percent. This disparity was even more significant among the smallest of small businesses. Jobs declined 14.1 percent in establishments with fewer than 50 employees, compared with 9.5 percent in businesses with 50 to 500 employees, while overall employment decreased 8.4 percent.

Financial crises tend to hit small firms harder than large firmsAs the academic literature underscores, small firms are always hit harder during financial crises because they are more dependent on bank capital to fund their growth. Credit markets act as a financial accelerator for small firms, such that they feel the credit market swings up and down more acutely.

Small businesses are back to creating two out of every three net new jobs in the U.S., but there remains a significant jobs gap. Small businesses have created jobs in every quarter since 2010, and are back to creating two out of every three net new jobs. But, as Brookings data reveals, we are still well below the job creation levels that we need to see to fill the jobs gap left in the wake the recession.

Bank credit, particularly through term loans, is one of the primary sources of external financing for small businessesespecially Main Street firmsand is key to helping small firms maintain cash flow, hire new employees, purchase new inventory or equipment, and grow their business.

Bank loans have historically been critical for small businessesUnlike large firms, small businesses lack access to public institutional debt and equity capital markets and the vicissitudes of small business profits makes retained earnings a necessarily less stable source of capital. About 48 percent of business owners report a major bank as their primary financing relationship, with another 34 percent noting that a regional or community bank is their main financing partner for capital.

In the current lending environment, where you sit often determines where you stand on the question of, is there a gap in access to bank credit for small businesses? Most banks say they are lending to small businesses, but major surveys of small business owners point to constrained credit markets.

Bankers say they are lending to small businesses, but have trouble finding creditworthy borrowers. Banks today say that they are increasing their lending to small businesses but that the recession has had a lingering effect on the demand from small business borrowers. In addition, bankers note the dampening effect of increased regulatory oversight on the availability of small business credit. Not only is there more regulation and higher compliance costs, there is uncertainty about how regulators view the credit characteristics of loans in their portfolios, making them less likely to make a loan based on “softer” underwriting criteria such as knowledge of the borrower from a long term relationship. Jamie Dimon, CEO and Chairman of JP Morgan Chase, noted in 2013 that, ‘Very few (small businesses) say, ‘I cant get a loan.’ Sometimes they say that, and it is true. I would say that happens more in smaller towns, where smaller banks are having a hard time making loans because the examiners are all over them”.

Small businesses claim that loans are still difficult to get during the recoverySome level of friction in small business credit markets is natural, and indicative of a financial sector working to allocate scarce resources to their most productive ends. It is also difficult to assess whether or not small firms being denied credit access are in fact creditworthy. Nonetheless, every major survey points to credit access being a problem and a top growth concern for small firms during the recovery, including national surveys conducted by the National Federation of Independent Businesses (NFIB) and regional surveys led by the Federal Reserve.

The data on the small business credit gap is limited and inconclusive, but raises troubling signs that access to bank credit for small businesses was in steady decline prior to the crisis, was hit hard during the crisis, and has continued to decline in the recovery as banks focus on more profitable market segments.

Small business lending continues to fall, while large business lending risesIn an absolute sense, small business loans on the balance sheets of banks are down about 20 percent since the financial crisis, while loans to larger businesses have risen by about 4 percent over the same period.

The banking industry in the aggregate appears increasingly less focused on small business lending. The share of small business loans of total bank loans was about 50 percent in 1995, but only about 30 percent in 2012. Moreover, small business owners report that competition among banks for their business peaked in the 2001 to 2006 period, and has sharply declined from 2006 to the present.

During the 2008 financial crisis, small businesses were less able to secure bank credit because of a ‘perfect storm’ of falling sales, weakened collateral and risk aversion among lenders. There are some lingering cyclical factors from the crisis that may still be constraining access to bank credit.

Small business sales were hit hard during the crisis and may still be soft, undermining their demand for loan capitalIncome of the typical household headed by a self-­employed person declined 19 percent in real terms between 2007 and 2010, according to the Federal Reserve’s Survey of Consumer Finances. And, the NFIB survey notes that small businesses reported sales as their number one problem for four straight years during the crisis and subsequent recovery.

Collateral owned by small businesses was hit hard during the financial crisis, potentially making small business borrowers less creditworthy todaySmall business credit scores are lower now than before the Great Recession. The Federal Reserves 2003 Survey of Small Business Finances indicated that the average PAYDEX score of those surveyed was 53.4. By contrast, the 2011 NFIB Annual Small Business Finance Survey indicated that the average small company surveyed had a PAYDEX score of 44.7. Moreover, the values of both commercial and residential real estate which represent two-­thirds of the assets of small business owners, and are often used as collateral for small business loans, were hit hard during the financial crisis.

Banks are more risk averse in the recovery. Measures of tightening on loan terms including the Federal Reserve Senior Loan Officer Survey, increased at double-­digit rates during the recession and recovery for small businesses, and have loosened at just single-­digit rates over the past several quarters. Loosening has been much slower and more tentative for small firms than for large firms.

Community bank failures increased and few new banks have started upTroubled and failed banks reached levels not seen since the Great Depression during the financial crisis of 2008, with the failures consisting mostly of community banksthe most likely institutions to lend to small firms. This environmentwhere troubled local banks appear unable to meet re-­emerging small firm credit needswould be an ideal market for new banks to emerge, but new charters are down to a trickle. A year recently went by with no new bank chartersthe first time in 80-­year history of the FDIC.

Regulatory overhang may be hurting small business lending. Banks continue to raise capital levels to appease risk averse bank examiners and other regulators post-­‑crisis, undermining their ability to underwrite small business loans, which are inherently riskier than consumer and large business lending. Federal Reserve economists have recently modeled that additional regulatory burdens are forcing banks to hire additional full-­‑ time employees focused on oversight and enforcement, which can hurt the return on assets of some community banks by as much as 40 basis points. Moreover, other studies have found that an elevated level of supervisory stringency during the most recent recession is likely to have a statistically significant impact on total loans and loan capacity for several yearsapproximately 20 quartersafter the onset of the tighter supervisory standards.

There also appear to be structural barriers that are impeding bank lending to small businesses, including consolidation of the banking industry, high search costs and higher transaction costs associated with small business lending.

A decades-­long trend toward consolidation of banking assets in fewer institutions is eliminating a key source of capital for small firmsCommunity banks are being consolidated by big banks, with the number of community banks falling to less than 7,000 today, down from over 14,000 in the mid-­1980s, while average bank assets continues to rise. This trend was exacerbated by the financial crisis. The top 106 banks with greater than $10 billion in assets held 80 percent of the nations $14 trillion in financial assets in 2012, up from 116 firms with 69 percent of $13 trillion in assets in 2007.

Search costs in small business lending are high, for both borrowers and lenders. It is difficult for qualified borrowers to find willing lenders, and vice versa. Federal Reserve research finds that small business borrowers often spend almost 25 hours on paperwork for bank loans and approach multiple banks during the application process. Successful applicants wait weeks or, in some cases, a month or more for the funds to actually be approved and available. Some banks are even refusing to lend to businesses within particular industries (for example, restaurants) or below revenue thresholds of $2 million.

Small business loans, often defined as business loans below $1 million, are considerably less profitable than large business loans.

  • Small business lending is riskier than large business lendingSmall businesses are much more sensitive to swings in the economy, have higher failure rates, and have fewer assets to collateralize the loan.
  • Assessing creditworthiness of small businesses can be difficult due to information asymmetryLittle, if any, public information exists about the performance of most small businesses because they rarely issue publicly trade equity or debt securities. Many small businesses also lack detailed balance sheets, use sparse tax returns and keep inadequate income statements. Community banks have traditionally placed greater emphasis on relationships with borrowers in their underwriting processes, but these relationships are expensive and have not in the past translated well to automated methods for assessing creditworthiness, which are favored by larger banks.
  • Costs of underwriting small business lending are also high due to heterogeneity of small businesses and lack of a secondary market. Heterogeneity of small firms, together with widely varying uses of borrowed funds, have impeded development of general standards for assessing applicants for small business loans and have increased costs of evaluating such loans. Moreover, the heterogeneity of small business loans has made it difficult to securitize and sell pools of small business loans in the secondary market.
  • Transaction costs to process a $100,000 loan are comparable to a $1 million loan, but with less profit. As a result, banks are less likely to engage in lending at the smallest dollar level. Some banks, particularly larger banks, have significantly reduced or eliminated loans below a certain threshold, typically $100,000 or $250,000, or simply will not lend to small businesses with revenue of less than $2 million, as a way to limit time-consuming applications from small businesses. This is problematic as over half of small businesses surveyed are seeking loans of under $100,000, leaving a critical gap in the small business loan market. Often times, the biggest banks refer small businesses below such revenue thresholds or seeking such low dollar loans to their small business credit card products, which earn higher yields.

Investment banks

 

Ppt  Investment Banking

 

1.  What is investment banking:  https://www.investopedia.com/terms/i/investment-banking.asp (video)

  • Investment banking deals primarily with the creation of capital for other companies, governments, and other entities.
  • Investment banking activities include underwriting new debt and equity securities for all types of corporations, aiding in the sale of securities, and helping to facilitate mergers and acquisitions, reorganizations, and broker trades for both institutions and private investors.
  • Investment bankers help corporations, governments, and other groups plan and manage financial aspects of large project

 

Investment banking is a specific division of banking related to the creation of capital for other companies, governments, and other entities. 

·        underwrite new debt and equity securities for all types of corporations,

·        aid in the sale of securities,

·        help to facilitate mergers and acquisitions, reorganizations, and broker trades for both institutions and private investors.

·        provide guidance to issuers regarding the issue and placement of stock.

For example: the scope of investment banks

·                       Market Making

·                       Merger and Acquisition Advisory

·                       Prop trading

·                       IPO and SEO underwriter

·                       Structured financial products

 

Example of Investment Banking

Suppose that Pete’s Paints Co., a chain supplying paints and other hardware, wants to go public. Pete, the owner, gets in touch with Jose, an investment banker working for a larger investment banking firm. Pete and Jose strike a deal wherein Jose (on behalf of his firm) agrees to buy 100,000 shares of Pete’s Paints for the company’s IPO at the price of $24 per share, a price at which the investment bank’s analysts arrived after careful consideration.

The investment bank pays $2.4 million for the 100,000 shares and, after filing the appropriate paperwork, begins selling the stock for $26 per share. Yet, the investment bank is unable to sell more than 20% of the shares at this price and is forced to reduce the price to $23 per share in order to sell the remaining shares.

For the IPO deal with Pete’s Paints, then, the investment bank has made $2.36 million [(20,000 x $26) + (80,000 x $23) = $520,000 + $1,840,000 = $2,360,000]. In other words, Jose’s firm has lost $40,000 on the deal because it overvalued Pete’s Paints.

Investment banks will often compete with one another for securing IPO projects, which can force them to increase the price they are willing to pay to secure the deal with the company that is going public. If competition is particularly fierce, this can lead to a substantial blow to the investment bank’s bottom line.

Most often, however, there will be more than one investment bank underwriting securities in this way, rather than just one. While this means that each investment bank has less to gain, it also means that each one will have reduced risk.

 

 

 

Investment banks’ earning potential:

image067.jpg

 

 

 

http://graphics.wsj.com/bank-earnings/

 

2.  Hedge fund, private equity, venture capital

 

§  Hedge fund: video by khan academy

 

§  Private equity and venture capital  Video by khan academy

 

3.  Causes of 2008 Financial Crisis

Warren Buffett Explains the 2008 Financial Crisis (video)

 

What Is a Mortgage-Backed Security (MBS)? https://www.investopedia.com/terms/m/mbs.asp

A mortgage-backed security (MBS) is an investment similar to a bond that is made up of a bundle of home loans bought from the banks that issued them. Investors in MBS receive periodic payments similar to bond coupon payments.

The MBS is a type of asset-backed security. As became glaringly obvious in the subprime mortgage meltdown of 2007-2008, a mortgage-backed security is only as sound as the mortgages that back it up.

How a Mortgage-Backed Security Works

Essentially, the mortgage-backed security turns the bank into a middleman between the homebuyer and the investment industry. A bank can grant mortgages to its customers and then sell them on at a discount for inclusion in an MBS. The bank records the sale as a plus on its balance sheet and loses nothing if the homebuyer defaults sometime down the road.

The investor who buys a mortgage-backed security is essentially lending money to home buyers. An MBS can be bought and sold through a broker. 

The Role of MBSs in the Financial Crisis

Mortgage-backed securities played a central role in the financial crisis that began in 2007 and went on to wipe out trillions of dollars in wealth, bring down Lehman Brothers, and roil the world financial markets.

In retrospect, it seems inevitable that the rapid increase in home prices and the growing demand for MBS would encourage banks to lower their lending standards and drive consumers to jump into the market at any cost.

That was the beginning of the subprime MBS. With Freddie Mac and Fannie Mae aggressively supporting the mortgage market, the quality of all mortgage-backed securities declined and their ratings became meaningless. Then, in 2006, housing prices peaked.

Subprime borrowers started to default and the housing market began its long collapse. More people began walking away from their mortgages because their homes were worth less than their debts. Even the conventional mortgages underpinning the MBS market saw steep declines in value. The avalanche of non-payments meant that many MBSs and collateralized debt obligations (CDO) based off of pools of mortgages were vastly overvalued.

The losses piled up as institutional investors and banks tried and failed to unload bad MBS investments. Credit tightened, causing many banks and financial institutions to teeter on the brink of insolvency. Lending was disrupted to the point that the entire economy was at risk of collapse.

In the end, the U.S. Treasury stepped in with a $700 billion financial system bailout intended to ease the credit crunch. The Federal Reserve bought $4.5 trillion in MBS over a period of years while the Troubled Asset Relief Program (TARP) injected capital directly into banks.

The financial crisis eventually passed, but the total government commitment was much larger than the $700 billion figure often cited.

 

 

Mortgage Backed Securites Explained by Analogy (video)

 

 

*** What is a Credit Default Swap (CDS)? ***  https://www.investopedia.com/terms/c/creditdefaultswap.asp

A credit default swap (CDS) is a financial derivative or contract that allows an investor to "swap" or offset his or her credit risk with that of another investor. For example, if a lender is worried that a borrower is going to default on a loan, the lender could use a CDS to offset or swap that risk. To swap the risk of default, the lender buys a CDS from another investor who agrees to reimburse the lender in the case the borrower defaults.

A credit default swap is designed to transfer the credit exposure of fixed income products between two or more parties. In a CDS, the buyer of the swap makes payments to the swap's seller until the maturity date of a contract. In return, the seller agrees that – in the event that the debt issuer (borrower) defaults or experiences another credit event – the seller will pay the buyer the security's value as well as all interest payments that would have been paid between that time and the security's maturity date.

Bonds and other debt securities have risk that the borrower will not repay the debt or its interest. Because debt securities will often have lengthy terms to maturity, as much as 30 years, it is difficult for the investor to make reliable estimates about that risk over the entire life of the instrument.

Credit default swaps have become an extremely popular way to manage this kind of risk. The U.S. Comptroller of the Currency issues a quarterly report on credit derivatives and in a report issued in June 2020, it placed the size of the entire market at $4 trillion, of which CDS accounted for $3.5 trillion.

Real World Example of a Credit Default Swap

Credit default swaps were widely used during the European Sovereign Debt crisis. In September 2011, Greece government bonds had a 94% probability of default. Many hedge funds even used CDS as a way to speculate on the likelihood that the country would default.

Credit Default Swaps (CDS) easily explained (video)

 

 Untangling credit default swaps (video, FYI)

 

 

 Credit Default Swap explained – the bear talks (video)

 

 

Julius Csurgo Explaining proprietary trading and its risks (video)

 

What is the Shadow Banking System?  https://www.investopedia.com/terms/s/shadow-banking-system.asp (video)

A shadow banking system is the group of financial intermediaries facilitating the creation of credit across the global financial system but whose members are not subject to regulatory oversight. The shadow banking system also refers to unregulated activities by regulated institutions. Examples of intermediaries not subject to regulation include hedge funds, unlisted derivatives, and other unlisted instruments, while examples of unregulated activities by regulated institutions include credit default swaps.

Understanding Shadow Banking Systems

The shadow banking system has escaped regulation primarily because unlike traditional banks and credit unions, these institutions do not accept traditional deposits. Shadow banking institutions arose as innovators in financial markets who were able to finance lending for real estate and other purposes but who did not face the normal regulatory oversight and rules regarding capital reserves and liquidity that are required of traditional lenders in order to help prevent bank failures, runs on banks, and financial crises.

As a result, many of the institutions and instruments have been able to pursue higher market, credit, and liquidity risks in their lending and do not have capital requirements commensurate with those risks. Many shadow banking institutions were heavily involved in lending related to the boom in subprime mortgage lending and loan securitization in the early 2000’s. Subsequent to the subprime meltdown in 2008, the activities of the shadow banking system came under increasing scrutiny due to their role in the over-extension of credit and systemic risk in the financial system and the resulting financial crisis.

Who Is Watching the Shadow Banks?

The shadow banking industry plays a critical role in meeting rising credit demand in the United States. Although it's been argued that shadow banking's disintermediation can increase economic efficiency, its operation outside of traditional banking regulations raises concerns over the systemic risk it may pose to the financial system. The reforms enacted through the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act focused primarily on the banking industry, leaving the shadow banking sector largely intact. While the Act imposed greater liability on financial companies selling exotic financial products, most of the non-banking activities are still unregulated. The Federal Reserve Board has proposed that non-banks, such as broker-dealers, operate under similar margin requirements as banks. Meanwhile, outside of the United States, China began issuing directives in 2017 directly targeting risky financial practices such as excessive borrowing and speculation in equities.

 Shadow banking: still big, still dangerous (video)

 

Shadow banking | Marketplace Whiteboard (video)

 

 

4.  Dodd Frank Act

What is Dodd-Frank? | CNBC Explains (video)

  • The Dodd-Frank Wall Street Reform and Consumer Protection Act targeted the sectors of the financial system that were believed to have caused the 2008 financial crisis, including banks, mortgage lenders, and credit rating agencies.
  • Critics of the law argue that the regulatory burdens it imposes could make United States firms less competitive than their foreign counterparts.
  • In 2018, Congress passed a new law that rolled back some of Dodd-Frank's restrictions

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act is a massive piece of financial reform legislation that was passed in 2010, during the Obama administration. It was created as a response to the financial crisis of 2008. Named after sponsors Senator Christopher J. Dodd (D-Conn.) and Representative Barney Frank (D-Mass.), the act contains numerous provisions, spelled out over roughly 2,300 pages, that were to be implemented over a period of several years.

The Dodd-Frank Wall Street Reform and Consumer Protection Act—typically shortened to just the Dodd-Frank Act—established a number of new government agencies tasked with overseeing the various components of the act and, by extension, various aspects of the financial system. When Donald Trump was elected President in 2016, he pledged to repeal Dodd-Frank; in May 2018, the Trump administration signed a new law rolling back significant portions of it.

The Volcker Rule

Another key component of Dodd-Frank, the Volcker Rule, restricts the ways banks can invest, limiting speculative trading, and eliminating proprietary trading. Banks are not allowed to be involved with hedge funds or private equity firms, which are considered too risky. In an effort to minimize possible conflicts of interest, financial firms are not allowed to trade proprietarily without sufficient "skin in the game." The Volcker Rule is clearly a push back in the direction of the Glass-Steagall Act of 1933, which first recognized the inherent dangers of financial entities extending commercial and investment banking services at the same time.

The act also contains a provision for regulating derivatives, such as the credit default swaps that were widely blamed for contributing to the 2008 financial crisis. Dodd-Frank set up centralized exchanges for swaps trading to reduce the possibility of counterparty default and also required greater disclosure of swaps trading information to increase transparency in those markets. The Volcker Rule also regulates financial firms' use of derivatives in an attempt to prevent "too big to fail" institutions from taking large risks that might wreak havoc on the broader economy.

 

5.   President Trump deregulates Dodd Frank Act

 

Criticisms of the Dodd-Frank Wall Street Reform and Consumer Protection Act

Proponents of Dodd-Frank believed the Act would prevent the economy from experiencing a crisis like that of 2008 and protect consumers from many of the abuses that contributed to the crisis. Detractors, however, have argued that the act could harm the competitiveness of U.S. firms relative to their foreign counterparts. In particular, they contend that its regulatory compliance requirements unduly burden community banks and smaller financial institutions—despite the fact that they played no role in causing the financial crisis.

The higher reserve requirements under Dodd-Frank mean banks must keep a higher percentage of their assets in cash, which decreases the amount they are able to hold in marketable securities. In effect, this limits the bond market-making role that banks have traditionally undertaken. With banks unable to play the part of a market maker, prospective buyers are likely to have a harder time finding counteracting sellers. More importantly, prospective sellers may find it more difficult to find counteracting buyers.

Dodd-Frank regulations good and bad for financial system, Harvard director says (video)

 

Trump signs the biggest rollback of bank rules since the financial crisis

PUBLISHED THU, MAY 24 201812:14 PM EDTUPDATED THU, MAY 24 20187:45 PM EDT by Jacob Pramuk (video)

 

President Donald Trump signed the biggest rollback of bank regulations since the global financial crisis into law Thursday.

The measure designed to ease rules on all but the largest banks passed both chambers of Congress with bipartisan support. Backers say the legislation will lift burdens unnecessarily put on small and medium-sized lenders by the Dodd-Frank financial reform act and boost economic growth.

Opponents, however, have argued the changes could open taxpayers to more liability if the financial system collapses or increase the chances of discrimination in mortgage lending.

“Dodd-Frank was something they said could not be touched. And honestly, a lot of great Democrats knew that it had to be done and they joined us in the effort,” Trump said before he signed the bill, surrounded by lawmakers from both major parties. “And there is something so nice about bipartisan, and we’re going to have to try more of it. Let’s do more of it.”

The measure eases restrictions on all but the largest banks. It raises the threshold to $250 billion from $50 billion under which banks are deemed too important to the financial system to fail. Those institutions also would not have to undergo stress tests or submit so-called living wills, both safety valves designed to plan for financial disaster.

It eases mortgage loan data reporting requirements for the overwhelming majority of banks. It would add some safeguards for student loan borrowers and also require credit reporting companies to provide free credit monitoring services.

Republicans have made slashing regulations one of their top priorities since Trump took office in January 2017. But Democrats, who largely support the Dodd-Frank reforms, helped to get the bank regulation bill through Congress. Seventeen Democratic senators voted for the bill, while 33 House Democrats supported it.

“When the president signs this, we put community banks back in the mortgage lending business, which is really exciting for me,” Sen. Heidi Heitkamp, D-N.D., told CNBC on Wednesday.

The senator said her colleagues who opposed it did so not because of community banking policies but because of the restrictions lifted on mid-sized and regional institutions.

Some Republicans, such as House Financial Services Committee Chairman Jeb Hensarling, argue the legislation did not go far enough to roll back regulations on banks. Certain lawmakers have pushed for a repeal of most or all of Dodd-Frank.

 

KEY POINTS

·        President Donald Trump signs a bill rolling back certain bank regulations into law.

·        The law, which Congress passed with bipartisan support, eases rules on all but the largest institutions.

·        Proponents argue the measures will help community lenders, while opponents contend it went too far to help mid-sized and regional firms.

 

 

Homework (due with final)

1.     What is MBS?

2.     What is credit default swap?

3.     What is shadow banking system

4.     What is Dodd Frank Act?

5.     Do you support deregulating Dodd Frank Act? Why or why not?

 

Wells Fargo tumbles, but Citigroup and JPMorgan shares jump—5 experts speak Survival of the fittest? (FYI)

 

https://www.cnbc.com/2020/07/14/big-banks-report-mixed-earnings-results-cramer-and-others-on-what-to-watch-now.html

 

As the big banks kick off earnings season with their quarterly reports, they are shedding light on two sides of banking that are faring very differently during the pandemic, market analysts say.

 

JPMorgan Chase’s results came in strong, with the firm reporting record revenue. On the other side of the spectrum was Wells Fargo, which said it lost $2.4 billion in the second quarter.

 

Here’s what five Wall Street professionals, including CNBC’s Jim Cramer, said about the banks on Tuesday:

 

‘What’s the catalyst?’

Aperture Investors Chairman and CEO Peter Kraus wondered if one of JPMorgan’s main catalysts this quarter could last:

 

“We expected trading income to be pretty robust and it turned out to be the case. That’s not surprising. We had an enormously fast-moving, very active market over the last three months, so, you would expect trading revenues to be good. They’re probably a little bit better than what people expected. But then the question is: is that trading revenue really sustainable? And you’re going to see that going into the future and that’s [where] consumer income is actually more predictive of what we might actually see in the next three months to six months. … The banks are cheap. There’s no doubt about that. But the question is what’s the catalyst that’s going to drive those earnings faster than the catalyst that drives the earnings in other investments?”

 

Long-term turnaround

Marty Mosby, director of bank and equity strategies at Vining Sparks, said Wells Fargo was more of a long-term bet:

 

“Wells Fargo’s a long-term ... turnaround story. We’ll have to see how the management team can now go from reconstructing and really not having any expectation on what they do this year to what they build towards in earnings power as we go into next year. Cutting the dividend to where it is gives them a little bit of wiggle room, so, this provides a base [and] gets their yield down to about where the market is. But there’s several other banks that have [gotten] ahead of the curve in a sense of their credit. The market is discounting them more because they think they’re going to have credit from the last recession, but they’ve done a lot better and they’ve also restructured their balance sheets. So, those are the banks that we really want to look at now. Wells Fargo’s a play as you go into, I think, 2021 or 2022.”

 

Winners and losers

Joe Terranova, chief market strategist at Virtus Investment Partners and a regular on CNBC’s “Halftime Report,” highlighted the differences between JPMorgan and Wells Fargo’s performance:

 

“There’s clearly a bifurcation between winners and losers. Just listen to the commentary from [Wells Fargo CEO] Charlie Scharf, who talks about being unsure about the length and severity of the economic downturn, and then read what [JPMorgan Chase CEO] Jamie Dimon says where he talks about the fortress balance sheet and being a port in the storm. So, on the money center banks, I think, clearly, JPMorgan is benefiting from trading revenue as a catalyst. I think that the technological investments that they have made over the prior years is allowing them, during this pandemic, to reach their customers in a more efficient [manner] than the other money center banks and I think that’s the reason why investors should be owning JPMorgan.”

 

‘Don’t own my stock’

Cramer, who hosts CNBC’s “Mad Money,” deciphered Wells Fargo’s earnings commentary:

 

“Charlie Scharf is a great banker. He’s got a very great pedigree. Visa. He was Bank of New York. But he comes out and basically says, ‘Don’t own my stock. You don’t want to touch my stock.’ And … Melissa [Lee] asked an analyst, ‘Is it a contrarian play?’ and I look at it and I say, ‘Well, let me check with Charlie Scharf, the CEO.’ Oops! No. Don’t buy it. Now, if you want to come in and buy it, you don’t really have Charlie’s blessing. I always like it when the CEO likes their stock, but maybe this is just one of those rare occasions because he bought a ton of stock at [$]28 and it is no longer at 28. You can buy it less than he did, but this is not the Jamie Dimon called shot that we all remember. … Wells Fargo’s a bank. It’s like Monopoly. It’s the community chest. And it’s a very good bank, but they do not have those trading desks that are crushing it. JPMorgan, by the way, had a great trading desk experience.”

 

The ‘all-clear sign’

David Konrad, managing director of equity research at D.A. Davidson, predicted the banks were unlikely to get an “all-clear sign” until 2021:

 

“I thought Jamie was pretty confident on the JPM call about the dividend, where it is and where the capital is. But, of course, a severe W-shaped economy puts that at risk. And so … getting through the next few quarters with better visibility of the dividend, and I think … looking at 1Q, 2Q of next year, kind of peaking credit costs, I think the market wants to see not only provisions coming way down, which, I think we’ll see that, but I think it’ll be tough for the banks to work with net charge-offs still ramping up. We want to see that delta come down as well. So, I think the big all-clear sign will be more mid next year.”

 

 

In trading results, Wall Street's big banks find some relief from tumultuous Q2 (FYI)

·          

https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/in-trading-results-wall-street-s-big-banks-find-some-relief-from-tumultuous-q2-59430160

 

·         AuthorDeclan Harty

·         ThemeBankingFintechFixed Income

·         SegmentBanking

·         TagsGlobal

·          

For Wall Street's biggest banks, 2020 is shaping up to be a heyday for trading.

JPMorgan Chase & Co., Citigroup Inc., Goldman Sachs Group Inc., Morgan Stanley and Bank of America Corp. all saw double-digit spikes in trading revenues during the second quarter as financial markets around the world reacted to the continued fallout from the COVID-19 pandemic.

"Trading revenues benefit from uncertainty and high volatility," Stephen Biggar, director of financial institutions research at Argus Research, said in an interview. "A whole slate of asset classes went for a wild ride in the second quarter."

In the U.S. equity market, for instance, the Cboe Volatility Index, a widely used gauge of implied volatility based on the S&P 500, had an average daily closing value of 34.49 in the second quarter. That was the highest quarterly average since the first three months of 2009, according to Cboe Global Markets Inc. data.

At JPMorgan, trading helped push the largest U.S. bank's quarterly revenues to a record high even as net income fell year over year. Revenues for JPMorgan's market and securities services unit, the business line that includes fixed-income and equity trading, jumped to $11.33 billion in the second quarter versus $6.39 billion a year ago. Fixed-income trading was up 99% year over year, while equities rose 38%. Citigroup posted a nearly 50% revenue increase in its markets and securities services business, driven by a 68% surge in fixed-income trading. Equity trading revenues for Citigroup fell about 3% year over year. Bank of America, the third big U.S. bank more focused on deposits, saw sales and trading revenue climb 31.3% in the second quarter year over year. Fixed income, currencies and commodities trading revenues climbed 50% in that period, while equities revenues increased 7%.

Still, JPMorgan, Citigroup and Bank of America reported lower profits across their entire companies in the second quarter largely due to dramatic increases in both banks' provisions for loan losses.

Goldman, on the other hand, posted a slight year-over-year increase to its quarterly profits — thanks almost entirely to its traders and investment bankers. Net revenues for Goldman's global markets business jumped 93% to $7.18 billion in the second quarter versus $3.72 billion a year ago. Fixed-income, currencies and commodities trading revenues grew 149% in that same period to a nine-year high, while revenues for equities swelled 46% to their highest quarterly level in 11 years. Investment banking reached record quarterly net revenues in the second quarter as well, Goldman said in its July 15 earnings report.

"There's no question that over the last decade in a period of very low interest rates and low volatility that [trading] has been a more commoditized service," Goldman Chairman and CEO David Solomon said July 15 during an earnings call. "In a period where there's enormous change and enormous volatility in markets, we became super busy because our clients are super busy."

Morgan Stanley was the biggest standout, posting a 50.2% year-over-year spike in earnings applicable to common shareholders. Sales and trading revenues surged 68% from the prior year, with fixed income trading up 167.7% and equities higher by 23%.

The market's second-quarter swings made the first half of 2020 one of the most robust opportunities for big bank trading desks in recent years.

A steady climb in asset prices in the wake of the 2008 financial crisis, along with several reforms designed to limit risk-taking by the biggest Wall Street banks, made for a challenging environment in recent years for most of those companies' trading desks. Executives at the largest U.S. banks have worked since then to push their companies further into steadier revenue sources such as wealth management and consumer banking.

The boon to trading activity in the first half may be only a blip, however.

Even as the coronavirus rages on in certain parts of the U.S., financial markets began to stabilize late in the second quarter and have continued to steadily rise in the first few weeks of July. JPMorgan Chairman and CEO Jamie Dimon said that trading, as a result, is not going to be nearly as active in the coming quarters.

"You should assume it's going to fall in half," Dimon said of trading revenues on a July 14 conference call. "We don't assume we have these unbelievable trading results going forward. And hopefully, we'll do better than that, but we simply don't know."

 

Federal Reserve and Monetary Policy

Part I - Fed Introduction

 

Fed Introduction ppt

 

The Structure of the Federal Reserve System is unique among central banks, with both public and private aspects. It is described as "independent within the government" rather than "independent of government.

The Federal Reserve does not require public funding, instead it remits its profits to the federal government. It derives its authority and purpose from the Federal Reserve Act, which was passed by Congress in 1913 and is subject to Congressional modification or repeal.

The Federal Reserve System is composed of five parts.

1.     The presidentially appointed Board of Governors (or Federal Reserve Board), an independent federal government agency located in Washington, D.C.

2.     The Federal Open Market Committee (FOMC), composed of the seven members of the Federal Reserve Board and five of the twelve Federal Reserve Bank presidents, which oversees open market operations, the principal tool of U.S. monetary policy.

3.     Twelve regional Federal Reserve Banks located in major cities throughout the nation, which divide the nation into twelve Federal Reserve districts. The Federal Reserve Banks act as fiscal agents for the U.S. Treasury, and each has its own nine-member board of directors.

4.     Numerous other private U.S. member banks, which own required amounts of non-transferable stock in their regional Federal Reserve Banks.

5.     Various advisory councils.

 

"It is not 'owned' by anyone and is 'not a private, profit-making institution'. Instead, it is an independent entity within the government, having both public purposes and private aspects. The U.S. Government does not own shares in the Federal Reserve System or its component banks, but does receive all of the system's annual profits after a statutory dividend of 6% on their capital investment is paid to member banks and a capital account surplus is maintained

 

In Plain English Fed St. Louise  (Cool video about Fed)

 

The Board of Governors

 

The Board of Governors of the Federal Reserve System, commonly known as the Federal Reserve Board, is the main governing body of the Federal Reserve System. It is charged with overseeing the Federal Reserve Banks and with helping implement the monetary policy of the United States. Governors are appointed by the president of the United States and confirmed by the Senate for staggered 14-year terms.

The Chair and Vice Chair of the Board are two of seven members of the Board of Governors who are appointed by the President from among the sitting Governors.

The terms of the seven members of the Board span multiple presidential and congressional terms. Once a member of the Board of Governors is appointed by the president, he or she functions mostly independently. Such independence is unanimously supported by major economists

Membership is by statute limited in term, and a member that has served for a full 14-year term is not eligible for reappointment.

The Chair and Vice Chair of the Board of Governors are appointed by the President from among the sitting Governors. They both serve a four-year term and they can be renominated as many times as the President chooses, until their terms on the Board of Governors expire.

 

https://en.wikipedia.org/wiki/Federal_Reserve_Board_of_Governors

 

Federal Open Market Committee

The Federal Open Market Committee (FOMC) is charged under United States law with overseeing the nation's open market operations (e.g., the Fed's buying and selling of United States Treasury securities). This Federal Reserve committee makes key decisions about interest rates and the growth of the United States money supply.

The FOMC is the principal organ of United States national monetary policy. The Committee sets monetary policy by specifying the short-term objective for the Fed's open market operations, which is usually a target level for the federal funds rate (the rate that commercial banks charge between themselves for overnight loans).

The FOMC also directs operations undertaken by the Federal Reserve System in foreign exchange markets, although any intervention in foreign exchange markets is coordinated with the U.S. Treasury, which has responsibility for formulating U.S. policies regarding the exchange value of the dollar.

The Committee consists of the seven members of the Federal Reserve Board, the president of the New York Fed, and four of the other eleven regional Federal Reserve Bank presidents, serving one year terms. Four of the Federal Reserve Bank presidents serve one-year terms on a rotating basis. 

 

By law, the FOMC must meet at least four times each year in Washington, D.C. Since 1981, eight regularly scheduled meetings have been held each year at intervals of five to eight weeks.

 

The FOMC holds eight regularly scheduled meetings during the year and other meetings as needed. Links to policy statements and minutes are in the calendars below. The minutes of regularly scheduled meetings are released three weeks after the date of the policy decision.

Federal open market committee meeting calendars, minutes and statement (2013-2018)

 

 

2020 FOMC Meetings

………

 

August

27 (notation vote)

Longer-Run Goals and Policy Strategy

September

15-16*

Statement:
PDF | HTML
Implementation Note

Press Conference
Projection Materials
PDF | HTML

Minutes:
PDF | HTML
(Released October 07, 2020)

November

4-5

Statement:
PDF | HTML
Implementation Note

Press Conference

December

15-16*

 

* Meeting associated with a Summary of Economic Projections.

 

Federal Reserve Banks

There are 12 regional Federal Reserve Banks, not to be confused with the "member banks", with 25 branches, which serve as the operating arms of the system. Each Federal Reserve Bank is subject to oversight by the Board of Governors. Each Federal Reserve Bank has a board of directors, whose members work closely with their Reserve Bank president to provide grassroots economic information and input on management and monetary policy decisions. These boards are drawn from the general public and the banking community and oversee the activities of the organization. They also appoint the presidents of the Reserve Banks, subject to the approval of the Board of Governors. Reserve Bank boards consist of nine members: six serving as representatives of nonbanking enterprises and the public (nonbankers) and three as representatives of banking. Each Federal Reserve branch office has its own board of directors, composed of three to seven members, that provides vital information concerning the regional economy.

 

image074.jpg

 

Map of the twelve Federal Reserve Districts, with the twelve Federal Reserve Banks marked as black squares, and all Branches within each district (24 total) marked as red circles. The Washington DC Headquarters is marked with a star. (Also, a 25th branch in Buffalo, NY had been closed in 2008.)

 

https://en.wikipedia.org/wiki/Structure_of_the_Federal_Reserve_System

 

Jacksonville Branch Directors  https://www.frbatlanta.org/about/atlantafed/directors/jacksonville

 

Member Banks

Each member bank is a private bank (e.g., a privately owned corporation) that holds stock in one of the twelve regional Federal Reserve banks. The amount of stock each member bank must buy is set to be equal to 3% of its combined capital and surplus of stock in the Reserve Bank within its region of the Federal Reserve System. All of the commercial banks in the United States can be divided into three types according to which governmental body charters them and whether or not they are members of the Federal Reserve System.

Type

Definition

national banks

Those chartered by the federal government (through the Office of the Comptroller of the Currency in the Department of the Treasury); by law, they are members of the Federal Reserve System

state member banks

Those chartered by the states who are members of the Federal Reserve System.

state nonmember banks

Those chartered by the states who are not members of the Federal Reserve System.

All nationally chartered banks hold stock in one of the Federal Reserve banks. State-chartered banks may choose to be members (and hold stock in a regional Federal Reserve bank), upon meeting certain standards.

Member banks receive a fixed, 6% dividend annually on their stock, and they do not directly control the applicable Federal Reserve bank as a result of owning this stock. They do, however, elect six of the nine members of Reserve banks' boards of directors

Other banks may elect to become member banks. According to the Federal Reserve Bank of Boston:

Any state-chartered bank (mutual or stock-formed) may become a member of the Federal Reserve System. 

 

 

Outline

Organization of the Federal Reserve System

 

Whole

·         The nation's central bank

·         A regional structure with 12 districts

·         Subject to general Congressional authority and oversight

·         Operates on its own earnings

 

Board of Governors

·         Seven members serving staggered 14-year terms

·         Appointed by the U.S. President and confirmed by the Senate

·         Oversees System operations, makes regulatory decisions, and sets reserve requirements

 

Federal Open Market Committee

·         The System's key monetary policymaking body

·         Decisions seek to foster economic growth with price stability by influencing the flow of money and credit

·         Composed of the seven members of the Board of Governors and five Reserve Bank presidents, one of whom is the president of the Federal Reserve Bank of New York, the other presidents serve as voting members for one-year terms on a rotating basis.

 

Federal Reserve Banks;

·         12 regional banks with 25 branches

·         Each independently incorporated with a nine-member board of directors, with six of them elected by the member banks while the remaining three are designated by the Board of Governors.

·         Set discount rate, subject to approval by Board of Governors.

·         Monitor economy and financial institutions in their districts and provide financial services to the U.S. government and depository institutions.

 

Member banks

·         Private banks

·         Hold stock in their local Federal Reserve Bank

·         Elect six of the nine members of Reserve Banks' boards of directors.

 

Advisory Committees

·         Carry out varied responsibilities

 

https://en.wikipedia.org/wiki/Structure_of_the_Federal_Reserve_System

 

 

FEDERAL RESERVE statistical release

H.4.1

Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks

November 5, 2020

https://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab9

 

 

For class discussion: The security holding has increased in the following balance sheet. Why? Does it has an impact on interest rate?

 

5. Consolidated Statement of Condition of All Federal Reserve Banks

Millions of dollars

Assets, liabilities, and capital

Eliminations from consolidation

Wednesday
Nov 4, 2020

Change since

Wednesday

Wednesday

Oct 28, 2020

Nov 6, 2019

Assets

Gold certificate account

    11,037

         0

         0

Special drawing rights certificate account

     5,200

         0

         0

Coin

     1,481

+        3

-      193

Securities, unamortized premiums and discounts, repurchase agreements, and loans

6,945,910

+    8,962

+2,974,463

Securities held outright1

6,540,758

+   10,919

+2,898,317

U.S. Treasury securities

4,538,087

+   10,901

+2,343,769

Bills2

   326,044

         0

+  260,034

Notes and bonds, nominal2

3,872,732

+    9,469

+1,891,737

Notes and bonds, inflation-indexed2

   297,163

+    1,201

+  174,392

Inflation compensation3

    42,148

+      230

+   17,606

Federal agency debt securities2

     2,347

         0

         0

Mortgage-backed securities4

2,000,324

+       19

+  554,548

Unamortized premiums on securities held outright5

   339,163

+      927

+  212,559

Unamortized discounts on securities held outright5

    -4,672

-       83

+    8,109

Repurchase agreements6

     1,000

         0

-  214,160

Loans7

    69,660

-    2,802

+   69,638

Net portfolio holdings of Commercial Paper Funding Facility II LLC8

     8,559

-       17

+    8,559

Net portfolio holdings of Corporate Credit Facilities LLC8

    45,663

+      186

+   45,663

Net portfolio holdings of MS Facilities LLC (Main Street Lending Program)8

    41,683

+      410

+   41,683

Net portfolio holdings of Municipal Liquidity Facility LLC8

    16,552

+        1

+   16,552

Net portfolio holdings of TALF II LLC8

    12,266

+      503

+   12,266

Items in process of collection

(0)

        53

-        6

-       23

Bank premises

     2,190

-        9

+        4

Central bank liquidity swaps9

     7,248

+      449

+    7,202

Foreign currency denominated assets10

    21,644

-       28

+    1,037

Other assets11

    37,993

+      719

+   10,822

Total assets

(0)

7,157,479

+   11,173

+3,118,036

Note: Components may not sum to totals because of rounding. Footnotes appear at the end of the table.



5. Consolidated Statement of Condition of All Federal Reserve Banks (continued)

Millions of dollars

Assets, liabilities, and capital

Eliminations from consolidation

Wednesday
Nov 4, 2020

Change since

Wednesday

Wednesday

Oct 28, 2020

Nov 6, 2019

Liabilities

Federal Reserve notes, net of F.R. Bank holdings

2,001,134

+    5,087

+  264,399

Reverse repurchase agreements12

   193,037

-    8,856

-   95,459

Deposits

(0)

4,799,036

+   12,932

+2,830,255

Term deposits held by depository institutions

         0

         0

         0

Other deposits held by depository institutions

2,979,537

+   32,281

+1,450,780

U.S. Treasury, General Account

1,618,568

-   34,471

+1,240,384

Foreign official

    21,264

+       13

+   16,081

Other13

(0)

   179,666

+   15,108

+  123,009

Deferred availability cash items

(0)

       155

-      661

-       43

Treasury contributions to credit facilities14

   114,000

         0

+  114,000

Other liabilities and accrued dividends15

    10,895

+    2,673

+    4,979

Total liabilities

(0)

7,118,258

+   11,176

+3,118,132

Capital accounts

Capital paid in

    32,396

-        3

-       97

Surplus

     6,825

         0

         0

Other capital accounts

         0

         0

         0

Total capital

    39,221

-        3

-       97

 

 

The Federal Reserve's Balance Sheet Explained (you tube)

 

Homework (due with final)

1.      What is the FOMC? How many members? How many times does FOMC meet each year? What is determined at the FOMC meeting?

2.      What is the reserve bank? In our area, where is the reserve bank located?

3.      What is the board of governor of the Fed? How many members? Who is the chair?

4.      What is the role of Fed?

5.      Is the Fed a private or a public entity? 

 

 

 

http://www.federalreserve.gov/releases/h41/20071129/

Fed Balance Sheet as of Nov 29th, 2007

(At that time, Fed assets = 882,848

 

 http://www.federalreserve.gov/releases/h41/20081128/

Fed Balance Sheet as of Nov 28th, 2008

 

 http://www.federalreserve.gov/releases/h41/20091127/

Fed Balance Sheet as of Nov 27th, 2009

  

http://www.federalreserve.gov/releases/h41/20101126/

Fed Balance Sheet as of Nov 26th, 2010

 

 http://www.federalreserve.gov/releases/h41/20111125/

Fed Balance Sheet as of Nov 25th, 2011

 

https://www.federalreserve.gov/releases/h41/20121129/

Fed Balance Sheet as of Nov 29th, 2012

 

 https://www.federalreserve.gov/releases/h41/20131129/

Fed Balance Sheet as of Nov 29th, 2013

 

https://www.federalreserve.gov/releases/h41/20141128/

Fed Balance Sheet as of Nov 28th, 2014

 

 https://www.federalreserve.gov/releases/h41/20151127/

Fed Balance Sheet as of Nov 27th, 2015

 

 

https://www.federalreserve.gov/releases/h41/20161125/

Fed Balance Sheet as of Nov 25th, 2016

 

 

https://www.federalreserve.gov/releases/h41/20171124/

Fed Balance Sheet as of Nov 24th, 2017

 

 

Open market operation (video)

https://www.youtube.com/watch?v=FNq_C4h3Srk

 

 

The Tools of Monetary Policy

https://www.youtube.com/watch?v=rcPEkmstDek

Part II: Monetary Policy

 

ppt

 

The Fed Explains Monetary Policy (video)

 

The Tools of Monetary Policy (video)

 

 

Fed pledges to keep low interest rates for years (video)

 

 

Topic 1: Three tools to conduct Monetary policy

 

 

image030.jpg

 

Central banks have three main monetary policy tools: open market operations (target fed funds rate), the discount rate, and the reserve requirement. Most central banks also have a lot more tools at their disposal.

 

Open market operations are when central banks buy or sell securities. These are bought from or sold to the country's private banks. When the central bank buys securities, it adds cash to the banks' reserves. That gives them more money to lend. When the central bank sells the securities, it places them on the banks' balance sheets and reduces its cash holdings. The bank now has less to lend. A central bank buys securities when it wants expansionary monetary policy. It sells them when it executes contractionary monetary policy.

The reserve requirement refers to the money banks must keep on hand overnight. They can either keep the reserve in their vaults or at the central bank. A low reserve requirement allows banks to lend more of their deposits. It's expansionary because it creates credit. 

A high reserve requirement is contractionary. It gives banks less money to lend. It's especially hard for small banks since they don't have as much to lend in the first place. That's why most central banks don't impose a reserve requirement on small banks. Central banks rarely change the reserve requirement because it's difficult for member banks to modify their procedures.

The discount rate is the third tool. It's the rate that central banks charge its members to borrow at its discount window. Since it's higher than the fed funds rate, banks only use this if they can't borrow funds from other banks.

Using the discount window also has a stigma attached. The financial community assumes that any bank that uses the discount window is in trouble. Only a desperate bank that's been rejected by others would use the discount window  

The Bottom Line

Central banks often hold three major monetary tools for managing money supply. These are:

  • Open market operations
  • Reserve requirement
  • Discount rate

These tools can either help expand or contract economic growth.

Monetary policies are aimed to control:

  • Inflation
  • Consumption
  • Liquidity
  • Growth

Aside from the three traditional monetary tools, the Federal Reserve possesses new, innovative ones, most of which were contrived to cope with the 2008 recession.  

https://www.thebalance.com/monetary-policy-tools-how-they-work-3306129

 

 

Topic 2: Easing (expansionary) vs. Tightening (contractionary) Monetary Policy

 

Macro Minute -- Contractionary Monetary Policy (video)

 

Quantitative Easing (QE) and How the Fed Responds to Financial Crises (video)

 

Tight, or contractionary monetary policy is a course of action undertaken by a central bank such as the Federal Reserve to slow down overheated economic growth, to constrict spending in an economy that is seen to be accelerating too quickly, or to curb inflation when it is rising too fast.

The central bank tightens policy or makes money tight by raising short-term interest rates through policy changes to the discount rate, also known as the federal funds rate. Boosting interest rates increases the cost of borrowing and effectively reduces its attractiveness. Tight monetary policy can also be implemented via selling assets on the central bank's balance sheet to the market through open market operations (OMO).

In a tightening policy environment, the Fed can also sell Treasuries on the open market in order to absorb some extra capital during a tightened monetary policy environment. This effectively takes capital out of the open markets as the Fed takes in funds from the sale with the promise of paying the amount back with interest.

 

 

In a tightening monetary policy environment, a reduction in the money supply is a factor that can significantly help to slow or keep the domestic currency from inflation. The Fed often looks at tightening monetary policy during times of strong economic growth.

An easing monetary policy environment serves the opposite purpose. In an easing policy environment, the central bank lowers rates to stimulate growth in the economy. Lower rates lead consumers to borrow more, also effectively increasing the money supply.

Many global economies have lowered their federal funds rates to zero, and some global economies are in negative rate environments. Both zero and negative rate environments benefit the economy through easier borrowing. In an extreme negative rate environment, borrowers even receive interest payments, which can create a significant demand for credit.

https://www.investopedia.com/terms/t/tightmonetarypolicy.asp

 

 

Topic 3: Fed Funds Rate vs. Discount Rate

 

The Federal Reserve's Discount Rate Explained in One Minute: From Definition to Implications (video)

 

What Is the Federal Funds Rate? (video)

 

Central banks most often use the federal funds rate as a leading tool for regulating market factors.

Federal funds rate is the target interest rate set by the Federal Open Market Committee (FOMC) at which commercial banks borrow and lend their excess reserves to each other overnight. The Federal Open Market Committee (FOMC), the monetary policy-making body of the Federal Reserve System, meets eight times a year to set the federal funds rate.

The federal funds rate refers to the interest rate that banks charge other banks for lending to them excess cash from their reserve balances on an overnight basis. By law, banks must maintain a reserve equal to a certain percentage of their deposits in an account at a Federal Reserve bank. The amount of money a bank must keep in its Fed account is known as a reserve requirement and is based on a percentage of the bank's total deposits

They are required to maintain non-interest-bearing accounts at Federal Reserve banks to ensure that they will have enough money to cover depositors' withdrawals and other obligations. Any money in their reserve that exceeds the required level is available for lending to other banks that might have a shortfall.

The end-of-the-day balances in the bank's account, averaged over two-week reserve maintenance periods, are used to determine whether it meets its reserve requirements. If a bank expects to have end-of-the-day balances greater than what's required, it can lend the excess amount to an institution that anticipates a shortfall in its balances. The interest rate the lending bank can charge is the federal funds rate, or fed funds rate.

https://www.investopedia.com/terms/f/federalfundsrate.asp

 

The discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal Reserve Bank through the discount window loan process.

While commercial banks are free to borrow and loan capital among each other without the need of any collateral using the market-driven interbank rate, they can also borrow the money for their short term operating requirements from the Federal Reserve Bank. Such loans are served by the 12 regional branches of the Fed, and the loaned capital is used by the financial institutes to fulfill any funding shortfalls, to prevent any potential liquidity problems or, in the worst-case scenario, to prevent a banks failure. This special Fed-offered lending facility is known as the discount window. Such loans are granted by the regulatory agency for an ultra-short-term period of 24-hours or less, and the applicable rate of interest charged on these loans is a standard discount rate. This discount rate is not a market rate, rather it is administered and set by the boards of the Federal Reserve Bank and is approved by its Board of Governors.

Borrowing institutions use this facility sparingly, mostly when they cannot find willing lenders in the marketplace. The Fed-offered discount rates are available at relatively higher interest rates as compared to the interbank borrowing rates, and discount loans are intended to be available as an emergency option for banks in distress. Borrowing from the Fed discount window can even signal weakness to other market participants and investors. Its use peaks during periods of financial distress.   https://www.investopedia.com/terms/d/discountrate.asp

 

 

 

Topic 4: Open Market Operation

 

 Segment 406: Open Market Operations (video of Philadelphia Fed)

 

Open Market Operations to Deal with a Recession (video)

 

Money supply and demand impacting interest rates | Macroeconomics | Khan Academy (video)

 

 Open market operations (OMO) refers to when the Federal Reserve buys and sells primarily U.S. Treasury securities on the open market in order to regulate the supply of money that is on reserve in U.S. banks, and therefore available to loan out to businesses and consumers. It purchases Treasury securities to increase the supply of money and sells them to reduce the supply of money.

By using this system of open market purchasing, the Federal Reserve can produce the target federal funds rate it has set by providing or else taking liquidity to commercial banks by buying or selling government bonds with them. The objective of OMOs is to manipulate the short-term interest rate and the supply of base money in an economy.

The Federal Open Market Committee (FOMC) is the entity that carries the Federal Reserve's OMO policy. The Board of Governors of the Federal Reserve sets a target federal funds rate and then the FOMC implements the open market operations that achieve that rate. https://www.investopedia.com/terms/o/openmarketoperations.asp

 

Fed Funds Rate  at https://www.bankrate.com/rates/interest-rates/federal-funds-rate.aspx

Prime rate, federal funds rate, COFIUPDATED: 11/17/2020

THIS WEEK

MONTH AGO

YEAR AGO

Fed Funds Rate (Current target rate 0.00-0.25)

0.25

0.25

1.75

What it means: The interest rate at which banks and other depository institutions lend money to each other, usually on an overnight basis. The law requires banks to keep a certain percentage of their customer's money on reserve, where the banks earn no interest on it. Consequently, banks try to stay as close to the reserve limit as possible without going under it, lending money back and forth to maintain the proper level.

How it's used: Like the federal discount rate, the federal funds rate is used to control the supply of available funds and hence, inflation and other interest rates. Raising the rate makes it more expensive to borrow. That lowers the supply of available money, which increases the short-term interest rates and helps keep inflation in check. Lowering the rate has the opposite effect, bringing short-term interest rates down.

 

 

Interest on Required Reserve Balances and Excess Balances  

http://www.federalreserve.gov/monetarypolicy/reqresbalances.htm

 

The interest rate on required reserves (IORR rate) is determined by the Board and is intended to eliminate effectively the implicit tax that reserve requirements used to impose on depository institutions. The interest rate on excess reserves (IOER rate) is also determined by the Board and gives the Federal Reserve an additional tool for the conduct of monetary policy. According to the Policy Normalization Principles and Plans adopted by the Federal Open Market Committee (FOMC), during monetary policy normalization, the Federal Reserve intends to move the federal funds rate into the target range set by the FOMC primarily by adjusting the IOER rate. For the current setting of the IOER rate, see the most recent implementation note issued by the FOMC. This note provides the operational settings for the policy tools that support the FOMC’s target range for the federal funds rate.

The Board will continue to evaluate the appropriate settings of the interest rates on reserve balances in light of evolving market conditions and will make adjustments as needed.

The interest rates on reserve balances that are set forth in the table below are determined by the Board and officially announced in the most recent implementation note. The table is generally updated each business day at 4:30 p.m., Eastern Time, with the next business day's rates. This table will not be published on federal holidays.

Data Download Program DDP

Interest Rates on Reserve Balances for November 19, 2020
Last Updated: November 18, 2020 at 4:30 p.m., Eastern Time

Rates
(percent)

Effective
Date

Rate on Required Reserves (IORR rate)

0.10

03/16/2020

Rate on Excess Reserves (IOER rate)

0.10

03/16/2020

 

 

 

What is discount rate?

http://www.frbdiscountwindow.org/currentdiscountrates.cfm?hdrID=20&dtlID= (Discount window borrowing rate)

 

Current Discount Rates

District

Primary Credit Rate

Secondary Credit Rate

Effective Date

Boston

0.25%

0.75%

03-16-2020

New York

0.25%

0.75%

03-16-2020

Philadelphia

0.25%

0.75%

03-16-2020

Cleveland

0.25%

0.75%

03-16-2020

Richmond

0.25%

0.75%

03-16-2020

Atlanta

0.25%

0.75%

03-16-2020

Chicago

0.25%

0.75%

03-16-2020

St. Louis

0.25%

0.75%

03-16-2020

Minneapolis

0.25%

0.75%

03-16-2020

Kansas City

0.25%

0.75%

03-16-2020

Dallas

0.25%

0.75%

03-16-2020

San Francisco

0.25%

0.75%

03-16-2020

 

 

 No Homework assignment. Please find time to work on term project which is due on the final date.

 

How the Fed Has Responded to the COVID-19 Pandemic (FYI)

 

Wednesday, August 12, 2020

 

By Jane Ihrig, Senior Adviser, and Gretchen Weinbach, Senior Associate Director, Federal Reserve Board of Governors, and Scott Wolla, Economic Education Coordinator, Federal Reserve Bank of St. Louis

The Federal Reserve’s (or Fed’s) mission is shaped by its mandate to promote maximum employment and stable prices for the American people, along with its responsibilities to promote stability of the financial system. So when the economy faces a crisis, as it has with the COVID-19 pandemic, the Fed takes forceful actions to minimize economic harm and set the stage for recovery when the worst is over.

The pandemic is causing tremendous human and economic hardship around the world. What kind of economic damage is it doing? Among other things, the COVID-19 crisis has triggered steep job losses and disrupted financial markets.

Understanding the Federal Reserve’s Actions in Response to COVID-19

The Fed’s actions in response to the COVID-19 shock can be grouped into three categories:

1.     Lowering the policy rate and keeping it low

2.     Stabilizing financial markets

3.     Supporting the flow of credit in the economy

#1 - Lowering the Policy Rate and Keeping it Low

First, the Fed’s monetary policymaking body—the Federal Open Market Committee (FOMC)—quickly lowered the target range for the federal funds rate. The federal funds rate, which serves as the FOMC’s policy interest rate, is the rate banks charge each other for overnight loans. During two unscheduled meetings on March 3 and March 15, the FOMC voted to reduce the target range for the federal funds rate by a total of 1½ percentage points, dropping it to near zero. The graph below shows the rapid decline.

In addition, starting with its March 15 statement, the FOMC has indicated that it expects to keep the policy rate at that level until the economy has weathered recent events and is on track to meet the Fed’s dual mandate. Movements in the policy rate influence other interest rates in the economy, such as those for home and car loans.

These steps have helped make borrowing costs low for households and businesses at a critical time. They are also intended to spur spending and investment when the economy emerges from the depths of the crisis.

 

#2 - Stabilizing Financial Markets

Second, the Fed took a number of steps to unfreeze key financial markets and to help them run smoothly. For example, trading conditions in the market for U.S. Treasury securities, which is critical to the overall functioning of the financial system, showed severe strains in early and mid-March. In other words, the prices of these securities were very volatile and it was difficult for sellers to find sufficient buyers. (For more discussion of these conditions, see the Fed’s May 2020 Financial Stability Report and a July 2020 speech by Lorie Logan, an executive vice president at the New York Fed.)

The blue shaded region of the graph below shows how quickly the Fed ramped up its purchases of Treasury securities—it bought around $1.7 trillion worth between mid-March and the end of June. The Fed also increased its purchases of mortgage-backed securities, as shown in green.

In general, the Fed’s purchases of securities keep markets working when assets are otherwise difficult to sell. The purchases also inject cash into the economy, and convey to the public that the Fed stands ready to backstop important parts of the financial system.

 

#3 – Supporting the Flow of Credit in the Economy

Third, to support the flow of credit to businesses, households and communities where it was not otherwise available, the Fed introduced several temporary lending and funding facilities. These facilities are formal financial assistance programs offered by the Fed to help eligible borrowers with funding needs. The Fed is authorized to use these lending—not spending—powers only in special circumstances and with the approval of the Treasury secretary.

You may have heard these kinds of emergency measures referred to as “13(3)” facilities. That’s because the Fed’s authority for these measures comes from Section 13(3) of the Federal Reserve Act.

Overall, the Fed has introduced multiple temporary facilities to support various types of funding and credit markets, as well as businesses of all sizes.

Two of the commonly discussed facilities are:

  • The Paycheck Protection Program Liquidity Facility, established to help small businesses so they can keep their workers on the payroll; this facility supports the related Paycheck Protection Program created by the Coronavirus Aid, Relief, and Economic Security (CARES) Act and administered by the Small Business Association.
  • The Main Street Lending Program (a set of five facilities), established to support lending to both small and midsized businesses and nonprofit organizations.

(For more information on all of the facilities, see the Fed’s Monetary Policy Report from June and Funding, Credit, Liquidity and Loan Facilities on the Board of Governors site.)

Setting the Stage for Economic Recovery

While primarily a health crisis, the COVID-19 pandemic has also significantly disrupted the U.S. economy and financial markets. In line with its mission, the Fed responded forcefully. During the initial several weeks of the crisis, the Fed used its interest rate policy to support the economy, took steps to stabilize financial markets, and introduced other measures to support the flow of credit to many sectors of the economy.

These actions help minimize harm to the economy and also set the stage for economic recovery when the public health crisis has sufficiently subsided.

Additional Resources

https://www.stlouisfed.org/open-vault/2020/august/fed-response-covid19-pandemic

Final will be posted on blackboard under course introduction on 11/21, Noncumulative, 50 T/F Questions  

 

All homework due; term project due,  with final

 

Happy Holidays

Happy Holidays